What is needed is a local currency intervention
If the country’s currency lost more than 10 percent of its value over the past four months and half of this depreciation happened in the past month, and if the currency kept depreciating despite a rate hike — albeit insufficient — a central bank must have held an emergency meeting over the weekend.
But this did not happen.
If your reference point is not the value of your currency but other factors such politics, your money will keep losing value.
Moreover, if you fail to raise the bar enough “to protect the value of the money you print” but you make some “acrobatic moves” to put the blame on insufficient liquidity of a foreign currency, your money will keep losing its value.
This is what happened in the last 10 days.
In the money markets, the three-month plus maturity interest rates are above 15 percent, while the one-year rate is 15.85 percent. The yield on two-year bond is 15.30 percent. The Central Bank’s recently lifted overnight interest rate stands at 13.50 percent.
There are problems with interbank pricing in the bond market; the spread between bid and ask prices is widening while the transaction volume has declined.
There are uncertainties regarding pricing in the bond market. Investors, particularly foreign investors, who had purchased bonds, but want to sell them now, are complaining about price margins. Thus they want to lower “the lira risks” by buying foreign currencies; this is the “FX hedge.”
As long as the Central Bank falls behind the curve, those uncertainties will prevail, prompting market participants to buy FX. Investors, who somehow seek to reduce their “Turkey risk,” buy FX to reduce their risks if they fail to sell the assets they hold.
The Central Bank has already fallen behind inflation. It has been eight days since it announced its revised inflation forecast. Its revised forecast, which is lower than market expectations, has become irrelevant. Moreover, the local currency has depreciated nearly 5 percent in eight days. The market added this depreciation to its own expectations.
That is why if it were a central bank that was “defending the value of its currency,” it would have held an emergency meeting at the weekend to “sufficiently” raise the interest rates. This would have been a level in line with where inflation would eventually reach, not in line with where “rate hike expectations” would be.
Turkey is one of the leading economies among so-called E-7 countries in terms of capital flows and its advanced financial and commercial structures. But when it comes to “fighting inflation,” it looks like an “underdeveloped” nation. I wish this could be a choice with no significant consequences. But we cannot avoid its effects.
The April inflation data showed that the pricing behavior has greatly deteriorated. The prices of 299 goods and services out of a total 407 in the CPI basket, or 73.5 percent, increased. Such deterioration had not been seen since 2003. The pass-through from the depreciation of the lira in eight days is 1 point.
250 basis points
The Central Bank must raise the interest rates by 2.5 points in order to show its determination to fight inflation and narrow the gap with the markets.
When the currency appreciated after the call for snap elections, Deputy Prime Minister Bekir Bozdağ said “the market’s reaction already showed the election results.” The reasoning behind his comment was that “they would not just let the currency depreciate ahead of the elections. They would allow the Central Bank to raise interest rates.” This was a rather naïve expectation. Unfortunately, the view that “the Central Bank will not raise the rates enough, the currency rates will skyrocket” is gaining currency now. In this circle, everyone who has FX debt or holds lira-denominated assets but cannot sell those assets tries to save themselves by buying FX.
The Central Bank on May 7 changed the FX reserve requirements to withdraw 6.4 billion liras of liquidity from the market and provide approximately $ 2.2 billion to banks. But this move only showed that the Central Bank was not dealing with problems at the core, but it tried to pull a rabbit out of the hat. The bank failed to pull the rabbit and the currency depreciated more.
Everybody knows that the problem is not foreign currencies but the lira, and the Central Bank must be aware of this. The bank signaled that “it cannot raise the interest rates, but it tries to take FX rates under control by pumping FX liquidity.” But this message from the bank did nothing but hurt the lira.
The problem is not with the money that someone else prints. The problem is with our own money. The problem is the depreciation of this lonely and beautiful lira.