LONG READ: A thinking exercise on Turkey and its lira

LONG READ: A thinking exercise on Turkey and its lira
By Akin Nazli in Belgrade May 26, 2020

The dollar to the Turkish lira rate has gradually descended since an all-time high of 7.27 was hit on May 6. In tandem with that trend, the financial media has been dominated by headlines suggesting that Turkey’s currency was recovering thanks to news of the Turkish central bank entering into talks with counterparts in various parts of the world to secure hard currency swap lines.

Unfortunately, the reports did not specify who exactly was buying Turkish lira (TRY) in response to the swap rumours; it would be rather handy to have this information because even if the speculation that swap talks were advancing was correct, as a matter of fact no swap line could actually help solve the lira’s fundamental problems.

Moreover, lagged data shows that foreign portfolio outflows from Turkey have continued and locals’ FX deposits have risen, while the FX reserves have declined. FX deposits at local lenders, of course, don’t amount to more than “bank records” that act to absorb real FX demand. But the indicator does show that the Turks have been in no rush to sell their dollars in exchange for lira.

Burning through reserves

The Turkish central bank has raised the FX-to-TRY swap market transaction limit of Turkey’s lenders to 50% of their FX market transaction limit from the previous 40%, Reuters reported on May 22.

On May 5, the figure had been raised to 40% from 30% in a move that came two weeks after the national lender upped the limit to 30% from 20%.

A 10pp increase in the limit translates to tapping around an additional $5bn from the local lenders, financial media reports have suggested.

As of May 15, the lenders had a total of $16bn in additional FX liquidity ($5.4bn at home and $10.5bn held in foreign bank accounts). This figure stood at $19bn as of May 1 and at more than $20bn in April. The figure declines as the central bank increases the banks’ swap limits.

The lenders actually had $85.3bn worth of FX liquidity as of May 15 but $54.4bn was already with the central bank and $14.5bn was in government paper.

In addition to the $16bn left at the lenders, the central bank had $49bn worth of gross FX reserves as of May 15, down from $77bn at end-February.

The central bank also had $36bn of gross gold reserves as of May 15. The national lender has not sold any gold reserves as yet.

The data on the central bank’s open swap stock is lagged. According to the latest statistics, the figure stood at $30bn as of end-March, while analysts calculate that more than $30bn was sold via state lenders in the first quarter of 2020.

To sum up, the administration tending to the Turkish economy had around $50bn at the central bank and $16bn (available to be swapped or to be tapped via FX-denominated domestic paper) at local lenders as of May 15, according to the latest available data. There is then the $36bn of gold at the central bank.

It should be noted that around $6bn of the $50bn is denominated in non-convertible Chinese yuan (CNY) and Qatari riyal (QAR). An additional $10bn in QAR entered the coffers of the Turkish central bank on May 20 after a swap deal expansion was agreed with Doha. That will simply help the balance sheet make-up. It’s a cosmetic job that will make it harder to follow the exact situation.

A swap deal would not even normally help with the “make-up” but the abovementioned “more than $30bn” thought to have been sold via state lenders has been calculated by working around inconsistencies in the central bank balance sheet.

Yes, there are just too many numbers and most of them are not exact figures—but we are dealing with the only possible way to have an idea as to what is going on in the lira market.

BoP, domestic demand, liquidity

With approximately $50bn in gross FX reserves, the administrators of the economy are in a position to manage the balance of payments (BoP) while avoiding a bank run at home and a liquidity crash in USD/TRY trading.

In the longer term, a sharp devaluation of the lira is unavoidable given that the country is out of joint in all respects, but it is better to leave longer term expectations to the fortune-tellers under the current global conditions.

Balance of payments

Although the officials charged with managing the Turkish economy have also managed to “zero” the reliability of the BoP data, the BoP still provides a framework for thinking on Turkey’s FX needs in its financial and economic interactions with the outside world.

Current account

According to the latest data, Turkey’s current account officially produced a $4.9bn deficit in March. The main driver was still the trade deficit, which came in at $4.3bn. There was also $1.4bn in outflows via primary and secondary income items, while services income fell sharply to $0.7bn.

In coronavirus-cursed April, the trade deficit arrived at $3.4bn, with foreign tourist arrivals (the main factor in services income) falling by 99%.

The government is aiming to curb the trade deficit with import compression measures, while the tourism efforts amid the ongoing pandemic are even more desperate.

Dividend payments were at the behest of the government capped at 25% of 2019 net income while, according to the latest international investment position data from the central bank, non-residents had $47bn at Turkish lenders; $32bn in FX deposits and $15bn in lira deposits.

Let’s say the government somehow manages to neutralise the ‘balance on goods and services’ as it would not be possible to import anything if at some point in time the country has no FX and cannot borrow or buy on credit.

However, there was a $12bn outflow via the primary income item in 2019 and a current account deficit of a minimum $10bn is expected for 2020, provided the government does not introduce capital controls on dividends and interest payments.

Financial account

Turkey’s real problem since the August 2018 lira crisis has been its financial account. It was systematically overlooked amid loud praise for Turkey’s adjustments in its current account and currency while at the same time billions of dollars flew out of the country.

As of March, a total of $7.7bn had departed via the financial account. There was on the other side a $0.8bn inflow through net foreign direct investment (FDI), with the 12-month rolling figure brought to $5.6bn.

Let’s consider that the FDI flows also converge to zero amid the current global conditions if fire sales in the wake of an even sharper lira devaluation and uncontrolled bankruptcies do not happen.

Portfolio outflows under financial account

The main driver behind the financial outflows was the portfolio investments account. Everyone has heard how foreigners are hurrying and scurrying away from Turkey. They sold a net $3.3bn in March.

It was interesting to see how a net $2.28bn of foreign financial asset purchases by banks in the month brought total portfolio outflows to $5.6bn.

Given the present market conditions, it is not possible for banks or others to officially buy securities abroad without permission. The March outflow could be attributed to the banks repurchasing their own eurobonds but, in any case, they would not be able to continue with this strategy.

According to the latest available weekly figures from the central bank, foreigners still had $7bn of domestic government bonds and $21bn of equities as of May 15.

The banks are buying up government paper at any price to meet the asset ratio requirements lately imposed by officials while the central bank is also purchasing government paper. So the foreign investors will have counterparts if they seek to offload their remaining $7bn of government paper but it would look even odder if they were to truly zero their holdings in the asset category.

In the equities market, things are a little bit harder to decipher. The only buyers are Turkish “gamblers” who are “playing Borsa Istanbul” under the lockdowns. The foreigners seem determined to run away at any cost.

Former central banker Ugur Gurses thinks the foreign investors are selling their lira assets like crazy since lira liquidity has dried up abroad. Former portfolio manager Murat Kubilay thinks they expect a meteor to hit Turkey and that they don’t want to be on the scene when it does.

In any case, the government should keep ready some $10-20bn worth of reserves for this account if it is not planning to impose additional capital controls.

A sovereign eurobond sale would help here but the Treasury may face a 10% coupon and Finance Minister Berat Albayrak’s latest investor meeting, during which the lira started sliding even as he made commitments to supposedly lend it some heft, was not helpful when it comes to preparing the ground for a successful eurobond issue.

There is no sign of an upcoming eurobond sale by the banks or corporates. Eurobond redemptions will be considered under the external debt refinancing item below.

External debt refinancing under financial account

As of end-March, Turkey was obliged to roll over a total of $151bn of external debt, excluding obligations to foreign branches and affiliates, in the next 12-month period.

BoP data suggested that the external debt rollover ratio for banks stood at 77% and for corporates at 94% in March.

The European Bank for Reconstruction and Development (EBRD) and the World Bank helped with loan rollovers in April and May, but the renewal rates remained more or less the same.

A rollover average of 90% means payments worth 10% of $151bn. Let’s say $10-15bn.

The problem in rollovers is a rather big one—such money does not exist in Turkey.

Unidentified flows

In March, $4bn took flight from Turkey via the net errors and omissions item. It seems that the outflows continued in April and May—President Recep Tayyip Erdogan issued a warning to those who were “smuggling” FX out of Turkey.

Sudan recently repatriated its former president Omar Al-Bashir’s $4bn. Al-Bashir was not a "world leader" like Erdogan. Erdogan may dig into his pockets or once more let down the money laundering gumshoes or increase pressure on some tycoons to return their money to the country.

However, it should be observed that the unidentified inflows channel has not worked out since last year.

Expectations and domestic FX demand

Global expectations obviously suggest shaky times ahead. New external shocks could undermine Turkey at any time during the remainder of 2020.

The ongoing war games Turkey is embroiled in in Syria and Libya, a new wave of the coronavirus or some other global surprises should be included on the list here.

In foreign policy, Ankara’s only visible allies are Donald Trump and Qatar. Some elements of Western establishments such as the UK government, Germany’s Christian Democrats and Chancellor Angela Merkel are shy of being pictured with Erdogan, and at the same time they show their institutional heritage in tying their hands back in ways that provide full support for the Turkish strongman’s crimes.

China and Japan do not bail out anyone. Vladimir Putin and other populists with limited means have nothing to offer Erdogan in $ terms.

Some efforts at reprising the role of “good kid” for the West were lately made by Turkey, but it’s the potential dollars in the pipeline that actually matters and what could really flow from this better behaviour?

The only possible solution—as advised countless times by sensible economists with no hope of imagining what goes on in Erdogan’s brain—is to hand the keys to Turkey’s ledgers to the IMF. There again, look at the case of Argentina. Even that solution might not drain this bog. Besides, to go back on his so-many-times-uttered pledge to run a country that never has need of the Fund on his watch, Erdogan would require a guarantee that he could not end up on trial in the international courts and that he would be able to do anything necessary to push back pressure for early elections.

There is no working out an equation for external help unless some kind of game-changing development occurs.

Within Turkey, everyone discusses the possibility of snap polls. This of course would translate into more demand for FX, because no-one knows what what would happen during the election process. Crud and fans spring to mind.

The air is thick with intrigue and apprehension. Kemal Can on May 22 looked at the nonstop snap polls talk in his column for Duvar English, headlined “What’s behind the AKP government’s restlessness?”. Exploring anxieties such as the very real fear among many, frustrated at the lack of answers, that the end of all Turkish democracy is at hand, he posed the question: “Snap elections or no elections at all?”

With only $50bn gross in FX and $35bn gross in gold reserves, the “no elections at all” option should be a bit tricky to achieve, given that the lira printed by the central bank is not edible and the country’s agricultural production is import-dependent.

In this respect, some shocking national security jeopardies such as a military coup attempt or jihadist or Kurdish PKK bombings in major cities, or some other surprise yet to see the light of day in Turkish politics, might press the reset button.

Some Erdogan adherents are not averse to targeting opposition figures with death threats. Pathetic provocations have also lately come back in vogue.

Another avenue is the “flashy package”. Market opportunities could be presented that would help enduring foreign besties such as the British Tories or foreign investor advisors muddy the picture as to the actual level of authoritarianism and lawlessness in Turkey. The dictatorial regime might then be suited and booted for new chapters.

Erdogan’s current crutch, ultra-nationalist MHP leader Devlet Bahceli, has, meanwhile, been teeing up some new legislation that would prevent two new political parties formed by ex-Erdogan allies from participating in elections.

The picture is nothing if not murky and, as Turkey’s leader of 17 years creates bigger and bigger problems in people’s lives, the quest for understanding as to what Erdogan is up to (does even he know what he is trying to do is another common enquiry) goes on.

“Within the debates regarding the rising political tensions, the dominating view holds that the government is attempting to bolster its power and remove the obstacles hindering this goal. A number of explanations are put forward. While some argue the government is seeking to consolidate its voter base and call for snap elections, others contend it is paving the way for fully-fledged authoritarianism and do away with elections altogether. Such claims are backed by the government’s moves against opposition figures and its blatant threats. In recent times, the main opposition Republican People’s Party (CHP) has become a main target [a mention of the non-stop attacks on the pro-Kurdish HDP could be made here—Ed]. Besides, the frequent assaults on media and civil society institutions corroborate this. A government’s ability to endure has to do with its actual competence and the nature of the opposition. But there’s little the government can do to remove its most formidable obstacle, that of structural and unsolvable problems,” Can wrote in his column.

“I’m saying that they will rig the elections. Understand it as you please. They will interfere with votes, as they already intervened in the past elections. They murdered our people at the ballot box,” Islamist opposition Felicity Party chair Temel Karamollaoglu remarked in an interview on Turkish daily Sozcu’s YouTube channel.

Felicity Party ballot box observers Hasan Aktas and Ilyas Aktas were killed and one person was injured in a shooting at a polling station in the eastern Anatolian Malatya province during the local elections of March last year. The attackers were reportedly relatives of the AKP’s mayoral candidate Mikail Suluk. Four people were given life sentences for the attack but that was before the latest amnesty law was introduced earlier this year.

July is seen a critical juncture as the parliament’s current MPs will qualify for retirement benefits in that it will be two years since the last general election. It is speculated that some MPs could resign from the AKP and that the opposition could then achieve a winning vote to call snap polls.

Erdogan and Bahceli will try to avoid losing the initiative in calling elections. The hopelessness when it comes to the prospect of a true economic recovery is one reason for them to keep control of the initiative and call for a vote at their desired moment. The Turkish economy will only collapse further as time goes on.

Poverty, which has been managed with social support payments for the masses that at the same time secures them as a source of votes, has turned to hunger. By any analysis, Erdogan has no chance in any kind of fair elections if he does not find some hard currency post-haste. This reality fuels the “no elections at all” fears. Erdogan may not make a similar mistake to the blunder that led him to call for the Istanbul “revote” that resulted in a humiliating defeat.

Supply, demand, divine promise

The lira supply is growing. The total value of TRY banknotes and coins in circulation jumped to TRY209bn as of May 15 from TRY149bn as of end-February, while TRY sight deposits jumped to TRY369bn from TRY262bn in the same period in parallel to booming loans and quantitative easing (QE) performed by the central bank.

The government deficit and domestic borrowing are booming too, while the USD supply is also expanding but almost none of it ends up on the USD/TRY trading board.

While hoping that some dollars printed by the Federal Reserve will make it through, the government is desperately trying to curb the lira supply for trading.

Turkish lenders’ daily volumes in swap transactions with foreign counterparts fell to $51mn on May 11 from the billions of dollars seen before limitations were imposed by banking watchdog BDDK, BloombergHT reported on May 21.

The latest scandal—the banning of leading international lenders from lira transactions for a few days—has caused side-effects. Clearstream and Euroclear Bank halted lira transactions. The transactions were revived on May 25 after the BDDK exempted them from limits placed on local lenders’ transactions with foreign counterparts.

With or without Clearstream and Euroclear, almost no foreigners are buyers on the lira board.

However, Turks are buying dollars as the lira deposit rates stand at around 8% (extract a 15% or 1.2pp tax on deposits for maturities up to six months) on average with lower margins going as low as 6% versus official inflation of 10% and the unknown level of actual inflation that people face in their daily lives.

The BDDK imposed on May 21 a one-day settlement delay on the purchase of more than 100 grams of gold while the Treasury classified non-physical delivery type precious metal (gold) purchases as FX transactions subject to a 0.2% Tobin tax.

On May 23, Erdogan hiked that Tobin tax to 1% from 0.2% while he has also increased the tax rate on bank bills to 15% from 10% as lenders were lately directing their customers to bills from deposits to meet their asset ratios.

The officials at the helm of the economy break out in cold beads of sweat at the idea of crowds of Turks streaming to the banks to demand their dollars. They damn well need to discourage any such notion but at the same time they offer no return on lira savings and introduce taxes on FX and gold. What if a critical mass of resident deposit holders decided to grab their greenbacks and invest in black market gold and FX? The hard currency held by such bank customers amounts to around $120bn. If great numbers of them decided enough was enough, the government would have no choice but to deploy stricter capital controls. For that deposited FX no longer exists in reality.

When will the lira see its next record?

Perhaps, the answer is hidden in the Turkish national anthem:

            “For soon shall come the joyous days of divine promise;

            Who knows? Perhaps tomorrow? Perhaps even sooner!”