Sunday, 16 May 2021

Why is the Turkish lira fluctuating?

Mammed Talibli

The Turkish lira depreciated by 15-17 percent after Turkish President Recep Tayyip Erdoğan fired the head of the Central Bank of the Republic of Turkey (TCMB). Such that in the last week, a dollar rose from 7.21 TL to 8.36 TL. So, the lira lost value against the dollar. The discount rate of the Central Bank increased from 17% to 19%.

By the way, the IMF ranked Turkey among the countries with the highest interest rates among 192 countries: Venezuela - 45.3%, Argentina - 38%, and Turkey - 19%.

The depreciation and appreciation of the national currency of any country is also a matter of trust in those governments. Over the past year, the dollar's fluctuation was natural and expected as a result of three changes in the chairman of the Central Bank, three changes in the chairman of the Turkish Statistical Institute (TÜİK), and two changes in the Minister of Treasury and Finance. Because the TCMB does not have a stable monetary policy. The chairmen of the Central Bank, who were changed frequently, have not met the expectations of investors.

What does the TCMB want to do?

The main function of Central Banks in the world is to determine the interest rate of the national currency. The Central Bank has two main functions: (i) to determine the interest rate of the national currency and (ii) to decide on the amount of money.

In Turkey, the Central Bank is not directed by the technocratic corps, although it is not completely independent. If the Central Bank depends on deputies, who are elected for 4-5 years, the decisions made by the Central Bank will be populist. It is natural that they are more interested in promoting economic "ventilation" for their terms of office. However, the Central Bank must determine a long-term monetary policy. For long-term economic decisions, short-term sacrifices must be made. This is how governments carry out structural reforms. From this point of view, the policy of the Central Bank should be subject to technocratic management. The policy of following political decisions cannot make the Central Bank effective. One of the main reasons for the sharp fluctuations in the Turkish national currency is its need to adapt more to populist and political decisions. It seems that the change of the chairman of the Central Bank four times in Turkey over the past year and a half creates fundamental shortcomings in the conduct of sustainable monetary policy.

Every time the new Central Bank pursues a policy, citizens' inflation expectations increase. At the same time, when people feel the signal of rising prices for goods, the desire to buy more of them increases. And as a result, aggregate demand rises.

Erdoğan's long-held notion that "interest is the cause of inflation" is no longer tolerated by any economic logic or reality. The main problem of economies is not high interest rates but high inflation. However, high interest rates are a result of inflation. Turkey has been wasting time on the results of this experiment "rabbit" for many years...

It would not be right to link Turkey's current fluctuations to the monetary policy alone. The reason is that the weakening of the national currency is due to the economic mistakes made by the Turkish economy so far. The TCMB decided on high interest rates, the lira depreciated more against the dollar, the next time it raised interest rates again, the lira depreciated again, and it had to buy dollars from abroad. Thus, Turkey wanted to stabilize the lira, on the other hand, increased foreign borrowing. However, the increase in interest rates is done in order to give states a certain economic opportunity to breathe. Interest rate growth in itself does not strengthen the economy but temporarily stabilizes it. It gives certain opportunities for the negative trends in the structure of the economy to move in the right direction. If you use it properly as a state, then these interest rate increases can turn the opportunity you create in the economy into a chance. For example, you must pursue an economic policy to reduce imports, including intermediate goods, needed for national production. You need to expand the range of dollar inflows into the country. You have to narrow down the dollar routes that flow abroad at the expense of imports. In this case, the interest rate corridor, which is a stabilizing factor, will have a positive impact on the economy. No, if you are going to be the bearer of a state that simply observes the increase in interest rates, then the idea that "interest will cause inflation" will prevail.

The main issue in Turkey's monetary policy is the lack of confidence in the lira. At the same time, this is due to the fact that the country's economy does not have a wide channel for obtaining dollars. On the one hand, you cannot get dollars, on the other hand, you borrow in dollars. So, the pace of dollarization in the economy is slowing down. Turkey's debt has already exceeded $ 463 billion. If we compare the last 1 year of public debt (domestic + foreign), we can determine how the growth took place. While the public debt was 1 trillion 410 billion TL in February 2020, this figure rose to 1 trillion 860 billion TL in February 2021. Debt growth in the last 1 year was 32% or 450 billion TL. This represents a very fast borrowing rate.

The weakening of the Turkish lira in Turkey is also due to limited foreign exchange reserves. Turkey's foreign exchange reserves are $ 95.4 billion. 85% of this is the reserves of commercial banks in the Central Bank. This is not considered foreign exchange reserves at all. Because these are obligations. These are mandatory reserve requirements of the TCMB. Turkey's foreign currency does not exceed $ 15 billion. This means that these symbolic foreign exchange reserves make up a very small part of the annual GDP (2020, $ 717 billion).

There are also serious problems in Turkey's balance of payments. The money coming in and out of the country is not in Turkey's favor. This so-called "current deficit" has been fluctuating between $ 30 billion and $ 70 billion annually in recent years. In particular, Turkey's dependence on energy components from abroad, including the import of oil and gas products, causes the outflow of tens of billions of dollars in foreign currency. This should be considered a risk factor for the lira.

True, I do not believe that the lira will lose further value. But in general, the strength of the lira does not depend on the policy of the TCMB, but on the structure of the economy. In other words, the work of the new Central Bank is not easy. It must carry out firefighting operations in the foreign exchange market.

Confidence in Erdoğan's government, both inside and outside Turkey, has been shaken. Regardless of the scale of what this government is doing and the strength of the team, it has become really difficult to convince market participants of the rules of civilized play. Manifestations of the generalized image of the economy are in the foreign exchange market, and the basis of severe fluctuations in the foreign exchange market is political power. When confidence is shaken, this is the result of both politics and economics.