Investment inflows pave way for Turkey to rebuild FX coffers

Foreign investors have snapped up Turkish assets in recent weeks, opening the window for the country to rebuild its stores of foreign currency that were severely depleted in an ill-fated attempt to prop up the lira.

Analysts have warned, however, that Turkey’s newly installed finance minister and central bank chief have their work cut out for them, given the scale of the rebuild needed and the damage that the pandemic is inflicting on one of the world’s biggest emerging markets.

The draining of Turkey’s FX coffers has been one of the overarching worries of foreign investors over the past two years, since reserves are considered a crucial insurance policy against the country’s large import bill and hefty foreign debt obligations.

Gross reserves, excluding gold, have hovered around a 15-year low in recent months, according to data from the Turkish central bank.

The picture is even more bleak once an adjustment is made for a contentious accounting method adopted by the central bank last year. When tens of billions of dollars borrowed through short-term swap arrangements with commercial banks are excluded from the bank’s balance sheet, net foreign assets — a proxy for net reserves — stood at a deficit of $52bn at the end of October, according to FT calculations. 

A key cause of the decline was an intervention aimed at halting a freefall in the lira. The central bank spent tens of billions of dollars, according to analysts, but has failed to stem a 24 per cent tumble in the currency since the end of 2019.

The scheme was the centrepiece of the turbulent tenure of Berat Albayrak, the son-in-law of president Recep Tayyip Erdogan who ran the country’s economy until his surprise resignation last month. His successor, former bureaucrat Lutfi Elvan, and a new central bank governor, Naci Agbal, have been left to pick up the pieces. 

Their task is a daunting one, but they have a chance to turn the tide, said Hakan Kara, a former Turkish central bank chief economist.

“There is an opportunity here,” he said. “With more credible people who are saying exactly what the market expects, that will attract some inflows [of foreign capital].”

Dwindling reserves contributed to downgrades by international rating agencies and alarmed foreign investors, who pulled roughly $13bn from Turkish stocks and bonds in the first 10 months of 2020, data from the central bank show.

The shake-up in the country’s economic management has lured back some foreign fund flows, with $1.9bn shifting back into Turkish assets in the three weeks after Mr Albayrak’s departure. 

Line chart of Non-resident securities transactions (rolling, $bn) showing Turkey has attracted inflows at the end of grim 2020

A decision last month to sharply raise the central bank’s main interest rate to 15 per cent, plus the lifting of other measures that had put pressure on commercial banks to lend, is expected to help slow the credit-fuelled, consumption-driven growth that was stoking a large current account deficit and contributing to the drain on reserves.

But the pandemic provides a challenging backdrop for correcting the trade imbalance. Meanwhile, Turkish companies continue to create demand for FX as they pay down foreign debts. Such factors mean it is likely to be a “relatively slow process to rebuild reserves,” said Paul Gamble, a senior director at rating agency Fitch.

If the country can attract large enough inflows of foreign money, the central bank could begin building its coffers by starting FX purchase auctions for the first time since 2011. Some analysts warn, though, that the time is not yet right.

“It’s too early,” said Haluk Burumcekci, an Istanbul-based economist and consultant, pointing to the relatively small size of recent foreign inflows and the fact that sceptical local investors have continued to buy dollars in recent weeks.

“If there is no de-dollarisation and the central bank starts buying foreign currency, the dollar will rise again [against the lira],” he said.

Line chart of Lira per US dollar showing Turkey's lira has tumbled this year despite currency intervention

Mr Kara said that further rate rises would be “very important” for creating the right environment for reserve-building. Raising the main rate to 17 per cent and keeping it there for six months would create a “virtuous circle” that he estimates could help the central bank to add $15-20bn to its war chest. The question is whether Mr Erdogan, a staunch opponent of high interest rates, is willing to tolerate further rate rises.

“That’s the biggest risk ahead,” he added.

Steps by the central bank to reduce its reliance on swaps, and the lifting of measures that prevented Turkish banks from performing similar transactions with foreign counterparts, would help restore the normal functioning of Turkey’s financial markets, analysts said.


Economist’s estimate of what Turkey could add to its FX reserves if it raises interest rates further.

But bankers expect the arrangement to be dismantled gradually to avoid an abrupt decline in the central bank’s reported reserves.

“I think public banks will continue to roll over swaps for a long time,” said one Istanbul banker.

The central bank nodded to a desire to increase reserves in the statement that accompanied last month’s rate rise.

Bulent Gultekin, a former Turkish central bank governor who is now a professor of finance at the Wharton School at the University of Pennsylvania, said that a comprehensive plan and good communication would be critical to “create an environment of confidence to reverse the capital flows.”

“It was never clear where they were going [with the previous policies] — that was the reason why they got into that mess,” said Prof Gultekin.

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