Policy Minefield Ahead for Turkey as It Unwinds Albayrak’s Legacy

Turkey’s new economic managers are racing to reverse the interventionist policies spearheaded by President Recep Tayyip Erdogan’s son-in-law, but their market-friendly U-turn could initially mean more volatility for the lira.

Since the ouster of the central bank governor and resignation of finance minister Berat Albayrak earlier this month, Turkey’s begun lifting restrictions meant to prevent speculators shorting the lira, abolished a rule compelling lenders to extend credit and raised interest rates by the most in over two years.

The return to market orthodoxy has been welcomed by investors, who’d balked at Erdogan’s contrarian assertion that higher rates fuel inflation. The logical next step, say analysts, will be to further ease limits on currency swaps and derivatives deals that local banks can carry out with foreign counterparts, which had made it prohibitively expensive to access the lira offshore.

That move would do little to rebuild dwindling foreign exchange reserves, however, and could increase pressure on the currency, at least initially.

Policy Minefield Ahead for Turkey as It Unwinds Albayrak’s Legacy

“Unwinding swap restrictions may create volatility in central bank reserves and the currency, which could weigh on market sentiment,” said Hakan Kara, who was chief economist at the central bank from 2003 until he was removed from the job last year. “The authorities should design a plan in coordination with banks to ease the offshore restrictions gradually and meanwhile conduct central bank FX purchases to replace the swaps.”

Officials could do just that. In an effort to rebuild depleted reserves, authorities are considering restarting auctions to buy dollars with liras for the first time since 2011, according to a person familiar with the matter.

As this mechanism would create new pressure on the already-fragile lira, economists say officials may first opt for Eurobond sales in an effort to increase foreign currency buffers, and hold off auctions until the exchange rate market normalizes.

The first Eurobond announcement came on the heels of the banking regulator announcement on Tuesday that it will repeal the so-called asset ratio rule. The Treasury mandated Goldman Sachs, HSBC and Morgan Stanley to arrange issuance of 10-year Eurobonds. More issuances are likely to come as the bank tries to recoup its reserves, according to a London-based analyst.

Asked to comment on the issue, a central bank official said details of the monetary policy tools and how they will be used would soon be made public for the sake of accountability, transparency and predictability.

Lira Defense

Until August, Turkey had sought to deter short-selling by essentially barring foreign investors from borrowing from local banks.

The tenure of Albayrak and the former central bank governor, Murat Uysal, was also marked by aggressive sales of foreign currency in a futile effort to prop up the lira without resorting to rate hikes. Turkey’s gross reserves dropped 22% this year to $82.4 billion, while net foreign-exchange reserves -- or holdings stripped of liabilities to lenders -- fell by more than half. When money borrowed from local lenders via swaps is stripped out from net reserves, they fall below zero, according to Bloomberg calculations.

It was the dramatic depletion of Turkey’s FX stockpile, according to several officials familiar with the matter, which finally persuaded Erdogan a change of personnel was needed.

Policy Minefield Ahead for Turkey as It Unwinds Albayrak’s Legacy

Changes made earlier this month mean banks can now sell foreign institutions liras worth up to 5% of their equity for transactions that mature in seven days. The cap is 10% for transactions maturing in a month and 30% for those maturing in a year.

Further reducing swap limits would narrow the discrepancy in yields between local and offshore markets, creating another option for Turkish banks seeking lira and encouraging carry traders to invest in the currency. It would also make it easier for speculators to bet against the lira and, because fewer lenders would resort to the central bank’s own mechanism, it could affect reserve levels.

On Tuesday, Turkey’s lira weakened past 8 per dollar for the first time in almost two weeks as a decline in liquidity magnified the impact of local investors’ demand for foreign currency.

State banks have not been selling foreign currency to defend the lira since the appointment of the new economy team, according to traders, signaling another major policy shift. On Thursday, the central bank raised the limit for traditional swap auctions, a reserve-boosting step which shows it’s fine tuning lira liquidity.

“It is difficult to move fast on this given thin liquidity in the FX market is making the lira more vulnerable to speculative attacks,” said Evren Kirikoglu, an independent market strategist in Istanbul before the swap announcement. “Therefore, I expect the restrictions to be eased gradually.”

©2020 Bloomberg L.P.

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