Turkish savers will decide the troubled lira’s fate

Turkey’s savers, rather than foreign investors, will likely decide whether a decision by the central bank to hike interest rates on Thursday will usher in a new period of stability for the beleaguered lira.

Turks have seen the value of their savings in liras dwindle over the past two years as the currency slumped to successive record lows against the dollar and inflation surged, raising memories of decades of financial instability.

In response, many have turned to dollars, euros and gold to protect their capital, leading to so-called dollarization of the economy.

Official data published on Friday showed Turks held a record $225.8 billion of foreign currency and precious metals as of Nov. 13, an increase of $1.5 billion from a week earlier. Foreign currency now constitutes about 56 percent of the cash held in current accounts and deposit accounts in Turkey compared with 50 percent a year ago, central bank figures show.

Turks are selling the lira even after President Recep Tayyip Erdoğan announced a shake-up of his economic team two weeks ago and speculation mounted that the central bank would hike its benchmark interest rate substantially. The bank did so at a meeting on Thursday, increasing the benchmark by 4.75 percentage points to 15 percent.

It appears that Turkish savers do not believe that the returns offered by banks on lira deposits offer enough protection for their savings.

Consumer price inflation in Turkey edged up to 11.9 percent in October, according to official data.

Many Turks have vivid memories of economic instability that stretch back long before a currency crisis in 2018, which brought the economy to the brink of a financial crisis and ushered in a deep recession

In January 2005, the government of then-prime minister Erdoğan implemented a mass, one-off devaluation of the lira, shaving six zeroes from the currency. Erdoğan characterised the decades-long depreciation of the lira as a “shame” and said his government was “reinstating its dignity”.

Fifteen years ago, the smallest coin in Turkey was 50,000 liras, the equivalent to 4 U.S cents, a value that reflected out-of-control inflation and a succession of economic crises. One dollar was worth 2.8 liras in the 1950’s. During a financial crisis in 2001, annual inflation hit 70 percent. Annual price increases were over 30 percent when Erdoğan’s government took power at the end of the following year.

By the end of 2004 you needed 1,350,000 liras to buy one dollar.

The lira rallied to as high as 1.15 per dollar just prior to the global financial crisis of 2008 as Turkey implemented sweeping economic reforms under an IMF loan programme. You now need to pay 7.61 liras to buy one dollar, or in old money, 7,610,000 liras.

Economic policy over the past two years has revived Turks’ memories of the country’s crisis-laden past.

Before the currency turmoil of August 2018, Erdoğan’s government had already set about eroding the economic rules that had enshrined that IMF loan programme. It had undercut the independence of the central bank and a myriad of other financial and economic institutions, including state-run banks, which were taken away from parliamentary oversight and into a sovereign wealth fund.

Victory in the presidential election in the summer of 2018 gave Erdoğan vast new executive powers as Turkey changed from a parliamentary to presidential form of government.

Upon his re-inauguration, Erdoğan immediately appointed his son-in-law as head of a merged Treasury and Finance Ministry, ending the term of a respected former Merrill Lynch economist, and awarded himself the power to hire and fire top central bank officials. He also became chairman of the Turkey Wealth Fund and over the following months replaced several senior members of a previously autonomous state-run institution responsible for calculating inflation and other key economic figures.

berat albayrak
Erdoğan on the election trail with his son-in-law Berat Albayrak

Erdoğan and his son-in-law Berat Albayrak set about engineering a borrowing boom based on low interest rates to lift the country out of a deep economic recession. State-run banks lent tens of billions of liras and private lenders were told to follow suit.

In July last year, the president sacked the governor of the central bank for failing to lower borrowing costs, which had been set at 24 percent to help protect the lira. By May, the central bank’s benchmark borrowing rate was at 8.25 percent, 3.1 percentage points below the rate of inflation. Savers also saw interest rates on their lira deposits fall towards and then below annual price increases.

The boom in borrowing and the government’s low interest rate policies meant the central bank was forced to sell tens of billions of dollars of its foreign currency reserves to stabilise the lira rather than raise borrowing costs. Its reserves, net of liabilities, soon sunk into negative territory.

Despite the bank’s heavy interventions in the currency market, the lira sunk to successive record lows, reaching 8.58 per dollar on Nov. 6. The following day, Erdogan sacked and replaced the governor of the central bank, realising that his political future may be under threat from financial meltdown.

The interest rate on savings in Turkey typically drives household demand for liras. The average rate on deposits of up to one month stood at 11.89 percent on Nov. 13, according to central bank data, insufficient to cover the cost of annual inflation. Rates on deposits of up to one year stood at 13.2 percent, it said.

While returns from bank deposits in Turkey have generally followed the benchmark interest rate, the central bank had already increased funding costs for banks via a so-called interest rate corridor to about 14.75 percent before Thursday’s rate hike to 15 percent.

To start reversing dollarization, interest rates on deposits in Turkey need to exceed annual inflation by 3 percentage points or more, Jurgen Odenius, a Principal and Economic Counsellor at PGIM Fixed Income, said in a report on Thursday. Despite the central bank rate hike, real rates may therefore fall short of what is needed to reverse dollarization, depending on the trajectory of inflation, he said.

The central bank and governor Naci Ağbal, along with newly installed Treasury and Finance Minister Lütfi Elvan, who replaced Albayrak last week, are now faced with the problem of accelerating inflation and public perceptions of price increases, as well as restoring Turkey’s economic and monetary credibility.

Turks are historically distrustful of official inflation figures. Recent data published by the government have entrenched that view as householders saw prices of many basic goods climb at a higher rate. Claims by the opposition media of alleged price-fixing by retailers, allegedly on the orders of government officials, have added to their suspicions.

A study of Inflation in Turkey by academics and researchers published in October showed monthly price increases were almost four times greater than official data.

Prices rose by 3.61 percent month-on-month in September versus the 0.97 percent increase reported by the Turkish Statistical Institute (TÜİK), according to the independent Inflation Research Group (ENAG).

Annual consumer price inflation in Turkey has remained curiously stable even as a slump in the lira’s value led to a jump in producer prices.  

CPI stood at 11.76 percent in July, 11.75 percent in August, 11.75 percent in September and 11.89 percent in October. Annual producer price increases surged to 18.2 percent from 8.3 percent in the same period.

Turkey’s consumer price inflation rate is expected to rise to 12.5 percent by the end of the year, according to a central bank survey of finance industry professionals and business leaders. Many economists are expecting a further increase at the start of 2021, to above 13 percent and then higher.

The opinions expressed in this column are those of the author and do not necessarily reflect those of Ahval.