Turks Cling to Dollars in Red Flag for Erdogan Plan to Save Lira

(Bloomberg) -- Turkish investors are still clinging to foreign currencies, undermining President Recep Tayyip Erdogan's plan to support the lira without raising interest rates.

Companies boosted their foreign-currency holdings by around $1.6 billion in the seven days through Dec. 24, taking advantage of a rally that saw the lira almost double in value that week. While households trimmed their positions by just over $100 million, it hardly put a dent in total foreign-currency deposits, which rose to a record $239 billion, according to the latest central bank data.

This dash for dollars in Turkey is a symptom of a monetary policy that for years has remained far too loose to put a lid on inflation and as a result debased the lira. It also highlights the challenges authorities face in convincing investors to shift their savings into the local currency, which has lost more than 85% of its value against the dollar since 2012.

“The reason why people accumulated foreign-currency up until today was distrust, and the trust issue is still there,” said Evren Kirikoglu, an independent strategist based in Istanbul.

Understanding Turkey's Bold Plan to Stabilize the Lira

Rather than raise borrowing costs to lure savers into lira accounts, the government says it will compensate lira holders for any currency losses that exceed the interest rate on their short-term deposits -- currently languishing around 19 percentage points below headline inflation.

The official narrative is that this new financial instrument is a game changer because it will sap demand for dollars and euros that has weighed on the currency, and at the same time allow for rates to remain low and spur growth.

Little Interest

The catch is that, so far, appetite for the product remains tepid, with just 84 billion liras ($6.3 billion) out of a total of 5.2 trillion liras of deposits moving into new foreign-currency linked deposits, according to Finance and Treasury Minister Nureddin Nebati.

“People don't seem to understand the new product and they are afraid that some future changes could prevent them from buying back the FX they sold,” Kirikoglu said, referring to dollars and euros they parted with to place money in these new lira accounts.

Taken together with the latest official reserves data, the flows suggest interventions in the currency market may have played a far larger role in spurring the recent advance in the local currency.

Last month, the lira surged by as much has 79% from a record low of 18.3633 on Dec. 20 to a more than one-month high of 10.2512. That coincided with a $3.53 billion drawdown in the central bank's net currency reserves in the week that ended Dec. 24, taking a drop since the end of November to $16 billion.

With inflation running at over 36% and Turkey's official reserves dwindling, the question for some is how much longer policy makers can stand in the way of dollar demand.

Currency Interventions

The size of recent interventions is reminiscent of operations carried out between 2018 and 2020, when state lenders routinely flooded the market with dollars unannounced to support the lira. The government has denied reports of so-called backdoor sales.

Turkey's gross reserves stand at $110.9 billion. Yet net reserves -- which many economists use as a gauge of how much firepower policy makers have at their disposal -- is now just $8.6 billion.

There are signs that the market is already faltering, with the lira sliding to 13.33 per dollar on Tuesday to edge back toward a record low and extending its decline from a high in December to 23%.

“I assume people won't be rushing to dollars anymore but the key point is to attract FX holders to the system, otherwise the central bank cannot continue to meet citizens' FX demand with its reserves,” Kirikoglu said.