A Sobering Up of Expectations On The Turkish Currency

CBT

The Central Bank of Turkey expects that the movements in its foreign exchange market will have a “temporary effect” on inflation and thus expect it to continue to slide further. The monetary regulator said that monetary policy is moulded by medium term and long term price stability goals. The regulator seems to be comfortable at “no hikes” policy despite the last acceleration in its core inflation indicators, added to the deteriorating medium term inflation expectation. The central bank reiterated its forward guidance of an improvement in current account deficit (excluding gold trade) and it expects the current account deficit to be below forecast by end of 2013.

CBT Meeting Minutes

The Central Bank of Turkey is hoping for the global capital flow environment to be better for Emerging Markets in coming months. The discrepancies between the statements of MPC members and Basci’s “defending the Turkish Lira as lions” rhetoric, taken with the Central Bank coming up with no concrete “new steps”, imply that the CBT is essentially making a global ‘macro/risk’ call rather than planning significant policy steps to defend TRY. Given the CBT’s modest FX reserve levels in the foreign exchange market and its decision not to use interest rates, Barclays believes that this is a very limited case though .

The Central Bank of Turkey might be expecting supportive actions and rhetoric at the G20 meeting, and/or IMF annual meetings in early October. But in Barclays’ opinion, its foremost belief must be that global rates markets will actually ‘relax’ once tapering actually starts. Thus it becomes clear that the US macro outlook does not justify further aggressive yield rises.

The Central Bank may in particular also expect support for its external funding situation from further easing measures by the ECB following the German elections on 22 September. The most possible scenario, would be another LTRO, that has significantly supported Turkish Lira in the foreign exchange market when it was first applied.

Overall, this may not be an unrealistic scenario, but it also highlights that Governor Basci’s comments must be perceived as mainly attempts at moral suasion. TRY remains at the mercy of the outlook for global flows into Emerging Markets. This leaves TRY to be potentially vulnerable. If ever TRY would really experience further sharp depreciation, the Central Bank would have to increase rates again, regardless of Governor Basci’s verbal commitment to not change policy rates from here. Such hikes would be justified by declaring that the ‘inflation outlook deteriorated’ rather than that TRY needs support, but the effect would be the same.

Reserve Option Mechanism

According to Barclays forex analysts, the Reserve Option Mechanism (ROM) will be “fine tuned” to sustain foreign exchange market liquidity. However, there are no concrete new steps yet.

Following Governor Basci’s comments, which had wordings such as “defending TRY as lions” and “interesting maneuvers”, many FX investors in the market had been anticipating potential new measures from Central Bank of Turkey such as intervention through forwards or swaps similar to the Brazilian Central Bank. However, the Central Bank did not mention any of these but rather presented what it can do with ROM. The Central Bank of Turkey has kept repeating it statement that there is “no funding” crisis in the foreign exchange market, but “a temporary period of re-pricing”, and therefore they are willing to use FX reserves to smoothen FX volatility, as well as introduce more predictability in short-term rates.

Forward guidance for funding rate remains at 6.75 to 7.75. The Central Bank of Turkey said that it will supply FX liquidity from the gross reserves via reserve option mechanism and FX required reserves (FXRR), of which the Central Bank currently has about USD60B in total. They give the split as USD32B under ROM and USD28B under FX required reserves. The Central Bank would bring down ROC (reserve option coefficients) or the FX reserve requirement ratio (RRR) to release foreign exchange market liquidity.

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