The Turkish lira rallied in chaotic second day of trading after President Recep Tayyip Erdogan unveiled a new savings plan that analysts described as a devious interest rate hike that could erode finances public.
Tuesday’s gains leave the currency up about 50% from a record low reached in the previous trading session.
The intense volatility was sparked by a new Erdogan plan to distract Turkish savers from the dollar and gold by compensating them for exchange rate losses if they held their money in lira.
The currency was recently trading at around 12.6 TL against the US dollar, after hitting a record low of 18.4 TL on Monday before changing course drastically. Monday’s fluctuations were the biggest on Refinitiv’s records dating back to the early 1990s.
Refet Gurkaynak, professor of economics at Ankara Bilkent University, described the new program as “in fact, a steep rise in interest rates”. He said it could bring stability to the currency, but warned it could have “dangerous consequences” as well.
This was echoed by Wolfango Piccoli, a Turkish analyst with consulting firm Teneo, who said the move amounted to a “stealthy rate hike” – and which would be determined solely by the exchange rate.
“This huge hike in interest rates pegged to the exchange rate means taxpayers will finance the rich so they don’t lose out on the [foreign exchange] before, ”he wrote in a note to clients, adding that the program would place almost all of the currency risk on the state.
Erdogan, a staunch opponent of high interest rates, has ordered a succession of rate cuts in recent months despite double-digit inflation.
While the Turkish president has claimed that his “new business model” will boost exports, investment and job creation, he has put enormous pressure on the Turkish lira. The currency had lost about 50% of its value against the dollar in the three months before Erdogan’s announcement.
An exodus of foreign investors from Turkey in recent years has meant that the pressure on the lira has come largely from Turkish citizens and businesses.
Reluctant to save money in lire, whose value has been eroded by soaring inflation and negative real interest rates, they turned to the dollar and gold instead. This in turn put additional pressure on the currency.
In a bid to reverse the trend towards “dollarization”, Erdogan announced Monday evening that his government would offer “a new financial alternative to citizens” which he said would alleviate their concerns about the impact of the pound’s fall. on their savings.
The government would compensate savers, he said, for any loss if the fall in the exchange rate exceeded the interest rate offered by banks.
“From now on, none of our citizens will need to change their savings from lire to foreign currencies, because they fear that the exchange rate will go up,” said the Turkish president.
Turkey’s treasury said the program would only be open to individuals, not businesses, and that they would be required to pledge to freeze their money for at least three months to qualify for the exchange rate guarantee.
Although he did not provide any details on how the initiative would be funded, analysts expressed concern that the Turkish Treasury would bear the risk of compensating savers for any exchange rate loss.
While Turkey’s public finances remain strong relative to many other emerging markets, the foreign exchange component of central government debt reached 60 percent of the total in October, up from 39 percent in 2017. This means that, every time the pound has slipped against the dollar, it has become more costly for the government to service its debt.
Citigroup said that, from the Treasury’s perspective, the new regime “could prove to be a more expensive alternative to tighter monetary policy in the event that lira deposit rates are lower than a depreciating currency. and thus negatively affect fiscal policy.
“We believe these measures may provide temporary relief as the government tries to continue implementing its new business model program,” said Luis Costa, currency strategist at Citi, adding that the bank was waiving its recommendation. to bet on further declines in the pound.
However, the program will do little to discourage Turkish savers from looking for assets other than lire as a hedge against rising prices, he added. “We do not see how this can solve the local currency asset issues in Turkey that arise from the [currency-led] inflation, ”Costa said.