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Keeping Lira on Short Leash Pushes Turkish Reserves to Limit

From a peak in late December, its net foreign-currency reserves have dropped around $9 billion.

Keeping Lira on Short Leash Pushes Turkish Reserves to Limit
Turkish 20 lira banknotes sit on the counter of a currency exchange bureau in Istanbul, Turkey. (Photographer: Kerem Uzel/Bloomberg)

(Bloomberg) -- Turkey’s central bank is bearing the brunt of an effort to shore up the lira and the costs are starting to add up.

From a peak in late December, its net foreign-currency reserves have dropped around $9 billion, according to Bloomberg calculations using official data. The stockpile now stands at just under $35 billion, near the lowest in half a year, and covers just a fifth of Turkey’s foreign obligations over the next 12 months.

If the monetary authority’s short-term off-balance sheet liabilities are excluded, its pot of money could be less than half of that. As of December, the policy maker had $18.2 billion of outstanding swaps coming due over the next year alone.

In a sign of growing concern over the state of its buffers, the central bank on Tuesday increased the amount of foreign exchange it could borrow from commercial lenders. In the first half of 2019, it had boosted these operations drastically to make up for a sudden drop in reserves.

Keeping Lira on Short Leash Pushes Turkish Reserves to Limit

The rundown comes despite a $4 billion Eurobond sale in February, further masking the scale of the depletion, which has accelerated over the past month. Net reserves are calculated by subtracting foreign-currency liabilities from foreign-currency assets and adding back the Treasury’s balance.

If public deposits are excluded from the calculation, and assuming there’s been no change to the central bank’s outstanding swap stock since December, the policy maker’s arsenal stood at $8 billion at the end of last week, according to Deutsche Bank AG.

The central bank says it’s misleading to focus on the net figures and urges investors to consider its gross reserves, which stand at just over $104 billion, including gold. Some analysts also point out that short-term borrowings can be rolled over indefinitely since the bulk of them are conducted with local banks.

‘Uncomfortable Levels’

Still, the stakes are growing for Turkey, where the exchange rate is a key safeguard in an economy with $168 billion of total external debt to roll over next year and where the current-account balance has swung back into deficit. With President Recep Tayyip Erdogan repeatedly calling on the central bank to bring borrowing costs into single digits this year, he’s giving it little leeway if it needs to raise interest rates to keep the lira in check.

“We are getting close to uncomfortable levels,” said Kaan Nazli, a senior economist and portfolio manager who helps oversee $26 billion of assets at Neuberger Berman in The Hague. He estimates Turkey has roughly $6 billion in financing needs in the coming two months.

“Given the reserve burn was double that in the first two months of the year without a significant amortization is concerning,” he said. “Add to that a more complicated global outlook for emerging markets given the coronavirus weighing on risk sentiment.”

Despite the latest concerted effort to bolster the currency by using state lenders to flood the market with dollars, the lira has weakened 6.5% over the past three months, by far the most in emerging markets, to the lowest level in nine months.

Turkey’s currency slipped past 6.16 per dollar for the first time since May this week, amid a global sell-off sparked by concern the spread of the virus will dent global demand. It was trading at 6.1577 as of 12:39 p.m. in Istanbul on Wednesday.

Swap Inflows

While the latest data showed a $1.3 billion pickup in the central bank’s net reserves on Friday, the increase can be almost fully accounted for by a fresh inflow of dollars from local lenders via swaps. The jump in borrowing -- through what had essentially become a dormant facility -- was the biggest since July.

Keeping Lira on Short Leash Pushes Turkish Reserves to Limit

Another complication is that state banks now appear to be approaching the regulatory limits in terms of how much more foreign currency liquidity they can provide to stem the slide. In the week ended Feb. 14, government-backed lenders were running a $4.6 billion short position, equivalent to about 15% of their regulatory capital. The limit is 20%.

“Worryingly large open short FX positions must be being opened within the system -- within the state-owned banks,” Timothy Ash, a strategist at BlueBay Asset Management in London, said earlier this month. “As long as the lira is being managed and remains stable, this is not a problem. But if we see another bout of FX weakness, the damage then revealed in the banking sector would be ugly.”

Keeping Lira on Short Leash Pushes Turkish Reserves to Limit

Diverging Views

The good news is that since the end of November, hard-currency deposits at local banks have remained relatively flat, a sign that households and companies aren’t panicking.

The downside for the lira, however, is that foreign outflows are showing no signs of abating. Foreign investors have yanked more than $1.6 billion out of the local-currency bond market this year alone, taking their holdings to a fresh record low.

Meanwhile, volatility is on the rise. Earlier this month, when the lira shot past the line state banks had been defending, trading volumes in the spot market between local lenders and offshore accounts reached an eye-watering $4.7 billion.

That’s more than double the daily average over the past year and the most since March, when concern over an unexpected drop in the central bank’s foreign-currency reserves gave way to one of the lira’s biggest intraday declines since the crisis in 2018.

“Turkey is heading very much in the wrong direction,” said Paul McNamara, a portfolio manager at GAM in London. “The question is does one go heavily underweight now, or later.”

“My concern about being too underweight now is that current-account deficit is still small by Turkey’s standards,” he said. “So, we’re watching these numbers.”

To contact the reporter on this story: Constantine Courcoulas in Athens at ccourcoulas1@bloomberg.net

To contact the editors responsible for this story: Onur Ant at oant@bloomberg.net, ;Alex Nicholson at anicholson6@bloomberg.net, Paul Abelsky

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