By guest contributor Sanjay Guglani, CIO, Silverdale Fund Management
The first part of this article expounded the situation in Turkey and its genesis.
What do capital markets expect from Turkey?
At the core of Turkey crisis is the free fall of Turkish lira in the absence of a credible monetary policy. The markets need to see the breaking of the vicious cycle of rising inflation and weakening lira through a sharp increase in interest rates (to slow lending, cool down demand, reduce imports, thus reduce the current account deficit) and assurances from the central bank of its intention to honour debt commitments with no capital controls.
What has Turkey done?
In mid-August, the Turkish central bank (CBRT) lowered its reserve requirement, releasing $10 billion of funding. It has also reduced local liquidity (by not offering one-week repos), forcing banks to either borrow at an expensive overnight rate of 19.25% or to convert dollars into lira. FX swaps have been limited to 25% of banks’ equity (previously 50%), which has severely curtailed borrowing and shorting of lira more difficult. Hence, it provided a temporary respite. Furthermore, most local banks have raised interest rates to circa 25% to stem outflows of deposits (the central bank provides an interest rate floor but it does not provide an interest rate ceiling).
Finally, on 13th September, the central bank increased the interest rate by 6.25%, way beyond market expectation of a 5% hike, thus stemming the currency rout. Erdogan also made it compulsory to trade domestically in Turkish lira, forcing many US dollar-denominated property rentals, car rentals, etc. to be renegotiated and redenominated. This forces residents to convert their US dollars into Turkish lira, indirectly boosting FX reserves. Turkey residents are estimated to have $86 billion of US dollar deposits.