Goldman says Turkey may face pre-election FX market turmoil

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Goldman Sachs has warned of the potential for foreign exchange market instability in the run up to Turkey’s elections following years of currency reserve depletion and other costly measures.

While not its base case, the Wall Street bank said problems could be triggered if savers and firms became worried that a shift to more orthodox economic policies under a new government would fuel short-term FX market turbulence.

“The current market uncertainty poses significant risks, in our view,” Goldman said in a research note published on Wednesday.

Authorities could offer local banks FX swaps and try to reassure those with money deposited in the depreciation-protected bank accounts introduced in 2021 to stop the lira’s plunge that year, but these measures may not work.

“Given the short-term nature of the instruments, time is unlikely to be on the authorities’ side,” Goldman’s analysts said. “Hence, we believe there will need to be interim solutions”.

If problems do take hold the lira would fall, especially given the sharp depletion of Turkey’s currency reserves in recent years.

Goldman estimates that once illiquid assets such as gold, bilateral swap lines and International Monetary Fund (IMF) special drawing rights are taken out of the equation, Turkey’s reserves amount to just $42 billion following its devastating earthquake last month.

That compares to a combined short FX position – or exposure – of the central bank and treasury of $260 billion. That has grown by $206 billion since mid-2018, mainly as a result of the FX-protected deposits and swaps conducted with domestic banks.

“There are significant liquidity risks involved if those two markets are unsettled” Goldman said, adding though that a return to more orthodox economic policies was likely be beneficial for Turkey in the long run.