Providing forex liquidity alone cannot take pressure off the lira

The Central Bank that provided additional forex liquidity by using the reserve option mechanism was forced to take new measures aimed at increasing forex liquidity by raising its foreign exchange deposits auction volume.

Those measures had some impact on the market but their effects remained rather limited. To summarize, it became clear that unless something is done about the Turkish lira that sharply lifts interest rates while providing more forex liquidity, the upward moves in forex rates cannot be stopped.

The markets initially did not react to the steps taken on the morning of May 9 when the United States dollar/lira rate went above 4.35. On top of the measures announced by the Central Bank came the urgent economic summit held at the presidential complex. Following the news regarding the summit, the exchange rate eased to 4.27, meaning that the measures taken by the Central Bank alone were not sufficient.

The bank raised its daily foreign exchange deposits auction volume to $1.5 billion from $1.25 billion. On May 8, the bank also announced a measure regarding the reserve option mechanism aimed at providing $2.2 billion liquidity to the market. Over the past three days, the authorities have announced measures to pump some $3.5 billion liquidity into the markets but the forex rate remained at elevated levels.

Japan Credit Rating Eurasia (JCR) chair Orhan Ökmen explained in a written statement why those measures failed.

“Opportunities for carry trade are still available while there is no systematic pressure on lira assets. Those two factors provide sustainability regarding the financing of the current account deficit,” Ökmen said. He recalled that at a time when external instabilities have heightened, the carry trade has continued because there are no restrictions on capital movements in Turkey.

Ökmen underlined that even in the form of borrowing, the Turkish economy still has access to forex liquidity. “Taking no action regarding interest rates but only adjusting the foreign exchange liquidity will not provide price stability and will not ease the pressure on the lira. It becomes difficult to ensure price stability that falls under pressure from both cost and demand,” he said.

Banking and financial stability 

Ökmen noted that the large scale “election economy” put into practice destroyed the corrective and softening effect that emerged with the announcement of the decision for snap elections and added that demand triggered by public finance will not boost the economy as much as expected but increase the funding costs, and distort both the price stability and external value of the lira.

“Implementations regarding the election economy will also adversely affect the ability of the banking sector and fiscal discipline to serve as an anchor for stability, because finances will be so high they will not allow the economy to fallow.” Ökmen noted.

“Turkey has no policies that could defend the value of the lira,” Ökmen said, adding that the requests for the restructuring of credits will inevitably affect the asset quality and liquidity balance of the banking industry.

At the end of his statement, Ökmen said given the current situation the fundamental risks for the country’s credit ratings to fall are still in place and new rating cuts may be on the way.