Turkey’s central bank appears to have used a series of backdoor actions to claw back the 5.4% depreciation suffered by the Turkish lira (TRY) prior to the weekend but markets wonder how long the healthier picture can last given currency stabilisation tactics employed by officials including President Recep Tayyip Erdogan threatening bankers whom he describes to election rally crowds as rogue.

Underlining the unsure ground the TRY now stands on, one measure of the lira’s implied volatility spiked on March 26 to its highest weekly reading since September, when Turkey was still fending off the currency crisis that broke out last summer.

March 26 also saw the central bank keep two auctions shut to gird the lira against the increasing loss of confidence in the currency shown by Turks who for a record 23 weeks in a row have been loading up with hard currency, pushing up recorded forex savings.

Clamour to close long lira positions
Bloomberg, meanwhile, on March 26 cited two people with direct knowledge of the matter in reporting that offshore funds were clamouring to close long-lira positions but were failing to find counterparties. Traders who rushed into short-term swaps to make hay from the lira’s attractive 24% yield over recent months were caught off guard by the currency’s sharp sell-off at the end of last week. They then all rushed for the exit at the same time.

In a note to investors on the action against speculative lira selling, Timothy Ash at BlueBay Asset Management said: “Extreme short term move to stabilise the lira before local elections, but collateral damage will be Turkish bond markets, as foreign investors will find it harder to hedge their TRY bond exposure. Pretty extreme measure by the Turkish authorities, and a bit weird in terms of the problem is not really foreigners selling TRY but locals via increased dollarisation. The Turkish authorities need to work on means to stem dollarisation and address the causes.”

Beginning late on March 25, Turkish banks started to keep lira swap market transactions in London well below a 25% limit set by the banking watchdog, four sources with knowledge of the matter told Reuters. It was not clear how much of the limit was being used.

Traders citing Refinitiv Eikon data said this tactic caused the lira overnight swap rate in London to soar to 330%—the steepest level seen since Turkey’s 2001 financial crisis—and the weekly swap rate to 125%. Last week, these rates stood at 22% and 24%, respectively.

The yield on Turkey’s benchmark 10-year bond, meanwhile, moved up to 18.06% from 17.35% on March 25. The main Istanbul stock exchange index, the BIST-100, lost 1.06% on March 25 after two days of losses.

Indirect rate hike
With the Erdogan administration and ruling AKP party clearly not keen on seeing the lira back in the wars ahead of the March 31 local elections, the central bank on March 25 introduced some unorthodox moves to get a grip on lira liquidity. An indirect rate hike of 150 basis points was put in place when the national lender stopped funding through one-week repos at 24.0%, its policy rate, and began lending at 25.5% from the overnight repo and depo windows.

Yatirim Finansman Securities said a rise in banks’ cross-currency swap limits with the central bank injected TRY5bn of liquidity on March 25.

Another move by the central bank was to stop regular $500mn overnight forex lending.

Yatirim Finansman said the real effects of the change in liquidity policy were more apparent in the offshore market for lira. The overnight forward implied (USDTRY) yield shot up to over 90% at the end of March 25’s trading session.

“This coupled with much lower global core yields and higher EMFX, squeezed offshore short lira positions, allowing lira to pare back some of Friday’s losses,” Yatirim Finansman said in a note to investors.

“Going forward, we would watch whether the astronomic rise in relatively thin size of offshore lira market would be enough to stabilize the currency,” the note added.

Causes of climbing dollarisation
Looking at the causes of climbing dollarisation in Turkey, Ash said there was “long term structural selling as many secular Turks just don’t like the direction of travel for the country”.

He also pointed to “official pressure on banks to keep TRY deposit rates low, to curb funding costs for banks, and help NIM [net interest margins] cleanse their balance sheets”. “The price,” he said “has been switching by locals from TRY to FX deposits as they don't think they are compensated for the inflation risks.”

“Related to that,” Ash went on, “I think [there are] heightened inflation expectations [among] the population—not helped by all the government's non market efforts to rein in inflation. Simply put, Turks, a nation of small shop-keepers, don't buy this policy as being sustainable over the long term. If you artificially suppress prices you risk a negative supply response and higher inflation down the line—101 agricultural economics.”