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November 21, 2013 4:44 pm
Turks are fiercely hoarding foreign currency. The reason? Their own remains weak and could get weaker.
The lira has been one of the worst performing emerging markets currencies since May, when investors first took fright at the US Federal Reserve’s plans to start scaling back its vast stimulus. Despite periodic rallies in riskier assets – reflecting changing bets on the timing of tapering – the lira remains 12 per cent down against the dollar since January.
Usually, Turks are sanguine about such fluctuations: households tend to sell foreign currency when the lira weakens and build dollar and euro deposits when it snaps back.
But since May, households’ foreign currency deposits have risen about 6 per cent to more than $70bn, suggesting savers expect rising inflation and further falls in the lira.
International investors share this view, considering Turkey to be one of the countries most vulnerable to a withdrawal of the Fed’s easy money, because it relies on short-term capital inflows to finance a gaping current account deficit.
Net outflows from Turkey’s bond market since the end of May jumped to $3.1bn in the second week of November, while net outflows from equity markets over the same period moderated to $154m.
Yet while other countries with shaky currencies, including Indonesia, India and Brazil, have raised interest rates since May, Turkey’s central bank apparently denied itself the most powerful tool in its armoury by ruling out interest rate rises for the foreseeable future.
Instead, it has relied on foreign exchange auctions, liquidity adjustments and “talking up” the lira.
The temptation for policy makers to take such a stance is understandable, given the invective Turkey’s prime minister, Recep Tayyip Erdogan, has levelled at an “interest rate lobby” he accuses of trying to stunt Turkey’s growth.
Turkish officials have been arguing that the currency’s slide is part of a relatively benign “repricing” in which a cheaper lira and higher yields on Turkish bonds help attract sufficient funds to keep financing the country’s current account deficit.
But by taking this approach, the central bank had “completely eradicated the idea that the lira will come back”, says Christian Keller, economist at Barclays Capital.
Now, policy makers are fighting back. On Tuesday, the central bank acknowledged that inflation would remain above target for some time due to the effects of recent swings in the exchange rate. It left interest rates untouched, but said it would end a weekly repo auction – a move that gives it more control of overnight lending rates and effectively tightens policy.
In a subsequent meeting with economists, it guided investors to view the interbank money market rate – which it expects to keep close to 7.75 per cent – as the main reference rate.
Emerging markets are taking a battering as investors withdraw at the prospect of higher global interest rates
“The central bank is trying to simplify and normalise policy,” says Murat Ucer, at the consultancy GlobalSource Partners. “They seem to have realised that, as far as inflation dynamics go, they have run out of excuses.”
However, economists say the central bank’s reluctance to raise its headline policy rate makes it less effective. “At the margin, this might help to lower currency volatility somewhat, contain credit growth and possibly anchor inflation expectations to some extent,” says Tevfik Aksoy, at Morgan Stanley. “That said, the central bank might have to deliver more if global conditions call for further tightening.”
If pressures on emerging markets intensify, one crucial question is whether companies will be able to finance a net short foreign exchange position that totalled some $166bn, or 20 per cent of gross domestic product, in August.
Turkish executives argue that the concern is overstated, since many companies had increased borrowing in other currencies purely to take advantage of the record low rates available earlier this year, with overall leverage still low.
Much of the FX debt has longer-term maturities: the short-term net FX gap in the non-financial corporate sector has shrunk since the summer to stand at a more manageable $12bn.
Economists say this remains a challenge – especially if households who used to offset corporate demand for foreign currency compound the problem. It is certainly a concern for the central bank, which was at pains to point out this week that growth in households’ foreign exchange deposits had now stalled.
Yet Turkish businessmen say they are used to navigating economic storms. Mehmet Even, vice-president at Zorlu Property Development & Investment, says: “We are very much flexible in acting. And we have endurance.”
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