IMF sees strong lira pressures, says Turkey should boost currency reserves

The International Monetary Fund said there appeared to be strong underlying depreciation pressures on the Turkish lira.

Turkey should rebuild its foreign currency reserves, which have declined significantly, and rein in rapid credit growth, the IMF said in a report on the global impact of COVID-19 published on Tuesday.

The IMF made the comments as it warned that global financial stress could increase the risk of debt defaults and the need for more financial support for economies with pre-existing vulnerabilities.

The Turkish lira sank to a record low in mid-May even as the central bank spent tens of billions of dollars of its foreign exchange reserves to defend the currency. The bank has left the lira exposed by slashing interest rates to 8.25 percent from 24 percent last July in support of the government’s pro-growth economic policies. Rates are in negative territory when taking account of inflation of 11.8 percent.

“The size and composition of external liabilities, coupled with relatively low reserves, continue exposing Turkey to liquidity shocks, sudden shifts in investor sentiment, and increases in global interest rates,” the IMF said. “The FX exposure of nonfinancial companies is high, with the potential to undermine bank asset quality.”

While near-term policies should cushion the impact of COVID-19 through temporary and targeted fiscal support, Turkey should preferably implement them within a package that helps secure greater external stability, the IMF said.

“If imbalances that existed prior to the COVID-19 outbreak persist in the medium term, policies should aim to strengthen external resilience and support a sustainable rebalancing of the economy,” the fund said. “Monetary policy, supported by efforts to rein in rapid credit growth, would aim to reduce inflation durably and strengthen central bank credibility while rebuilding reserves.”

Turkey’s government has instructed state-run banks to flood the economy with cheap loans and pressured other lenders to follow suit. Meanwhile, it has encouraged banks to restructure the foreign currency debts of the corporate sector, which ballooned in the aftermath of the global financial crisis of 2008. That debt has become more expensive to repay as the lira weakened.

The IMF also called on the government to carry out focused structural reforms to increase resilience to shocks, strengthen the broader public sector balance sheet and improve transparency.

“These could include efforts to bolster the business climate, including by further strengthening Turkey’s insolvency and corporate restructuring frameworks,” it said.

The fund said Turkey’s gross foreign currency reserves had dropped to 67 percent of its Asset Reserve Adequacy (ARA) metric in May from 85 percent at the end of 2019. Reserve coverage of external financing requirements fell to 49 percent in mid-May from 64 percent in 2019, it said.

“Significant accumulation of reserves over the medium term is needed given sizable external liabilities and dependence on short-term and portfolio funding,” the IMF said.

Turkey’s net international investment position (NIIP), which measures the difference between an economy’s external financial assets and liabilities, was expected to increase to about -32 percent of gross domestic product by 2025 as the economy rebalances in the post-COVID-19 environment, the IMF said. That improvement would be driven by a decline in liabilities, mainly loans, it said.