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Sustained rate hikes fail to reverse Turkish lira slump

Istanbul's Grand Bazaar. The number of unemployed aged 15 and over declined by 161,000 to 3.2 million Wikimedia Commons/David Berkowitz
Istanbul's Grand Bazaar. The apex bank said that the current policy rate will be maintained until there is a significant decline in monthly inflation
  • Lira predicted to weaken further
  • Fall of 93% in a decade against dollar
  • Rate hikes hinder economic rebalancing

Turkey’s near-quadrupling of interest rates in the past three months has slowed but not yet reversed a long-term slump in the country’s currency, the lira.

It is widely expected to tumble to further record lows before the end of 2023.

The currency’s ongoing weakness spells trouble for efforts to rebalance the economy, and the country’s central bank, which has vowed to bring annual inflation down to 5 percent. This is less than one-tenth of August’s eight-month peak of almost 59 percent.

Turkish president Recep Tayyip Erdoğan had long claimed high interest rates were the cause, not the cure, for price rises.

The central bank steadily reduced rates to 8.5 percent in February from 19 percent in 2021. But these accelerated a long-term decline in the lira and sent inflation soaring.

Gloomy outlook

Re-elected in May, Erdoğan has since changed tack, appointing Mehmet Şimşek as finance and treasury minister and Hafize Gaye Erkan as central bank governor. Both are former finance executives, hired to help soothe jittery markets.

The Istanbul stock market has surged to record highs, but the lira has found little sustained support. It slumped to all-time lows against the dollar last week.

The currency has fallen 93 percent versus the dollar over the past decade and 68 percent in the past two years alone. It was trading at 27.4 lira to the dollar last Thursday and could slip to 30 before year-end, economists believe.

That gloomy outlook comes despite the central bank raising the benchmark rate to 30 percent.

The rate hikes have at least reduced the likelihood of ratings agencies downgrading Turkey, according to Serhan Gok, an Istanbul-based economist and fund manager at Arista.

Were they to do so, Turkish banks would struggle to roll over syndicated loans with international lenders.

Syndicated loans are a key source of funding for Turkey, Gok explained, along with tourism revenue, unofficial cross-border trade and swap agreements with Gulf countries.

“We were on the brink of losing one of these funding sources, which is why the rhetoric changed so sharply and Şimşek was appointed,” said Gok.

Challenges ahead

Interest rates on lira savings accounts surged to 31 percent as of September 8 from almost 25 percent on August 18.

A central bank statement last Thursday added that demand for lira-denominated investments had increased due to the benchmark rate hikes and a simplification of banking rules.

Improved returns should help convince Turks to hold more local currency savings. On September 15, lira-denominated deposits represented 61 percent of deposits and foreign currency deposits the remainder.

“There are huge challenges ahead,” said Gok. “Interest rates need to be increased substantially further.”

The central bank in August announced it would unwind a lira deposit scheme that protects savers against adverse currency moves. The initiative’s aim was to persuade customers to convert foreign currency savings into lira.

FX-protected deposits have declined to $122.3 billion on September 21. This was down from a peak of $127.6 billion on August 24 banking regulator data shows.

Turkey's finance minister Mehmet SimsekReuters
Turkey’s finance minister Mehmet Şimşek needs to increase the country’s exports, but interest rate hikes won’t help
Virtuous circle

“That’s a positive sign. We’ve still got a long way to go to properly stabilise the lira, but it’s a good start,” said Tunc Yildirim, managing director at Istanbul’s Unlu & Co.

“If you can create an atmosphere where foreign and local investors trust you, then once people start pulling money in, it becomes a virtuous circle because those who haven’t invested feel left out and follow too.”

The huge interest rates on lira savings accounts should more than offset any further currency declines versus the dollar.  

Turkey’s banks cannot function normally while the FX-protected deposit accounts remain, warned Guldem Atabay, an Izmir-based independent economist.

“It will take at least two more years for these accounts to be fully abolished,” said Atabay.

Finance minister Şimşek is tasked with rebalancing Turkey’s economy so that it relies less on domestic demand, where rampant credit growth helped stoke inflation.

More exports are also needed to help improve the country’s balance of payments and attract investment.

As of September 8, credit card borrowing had increased by 107 percent this year. Vehicle, personal and housing loans expanded by a combined 54 percent over the same period. Lira-denominated commercial loans grew 61 percent.

Rate hikes

Further rate hikes will slow economic growth and raise financing costs for businesses. That could play badly with supporters of the ruling AK Party and weaken Şimşek’s position. 

Turkey’s real GDP will expand 2.2 percent in 2023, S&P Global forecasts, down from an estimated 5.3 percent last year. Growth will be even lower in 2024, at 1.4 percent, according to the ratings agency.

Şimşek and Turkish business leaders met with US investors in New York in mid-September. The minister is expected to make similar trips to London, the main investor hub for Turkish assets, and another to East Asia before the end of this year.

S&P forecasts Turkey’s budget deficit will be 5.1 percent of GDP, its highest since 2009. The rating agency also predicts the country’s current account deficit will reach a 10-year peak of 5.4 percent of GDP.

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