Alla Turca exchange rate regime in Ankara

Even though its name is “floating exchange rate regime,” the current one in Turkey can only be called “commanded foreign exchange regime.” Some may object to that and suggest “managed floating rate regime.” If it was the latter, then the Central Bank would have openly done it. Everybody would have been informed of a rate regime which has targets, a framework and a system. But we do not know anything about this “dystopian regime.”

Public banks in Turkey obeying political orders they have received are “defending the foreign exchange rate” for 24 hours in the currency markets for more than a year. While they are at it covertly, now, for a couple of weeks, at the ministry and Central Bank Governor levels, even though with a low tone, they have accepted it with words meaning, “We are doing it for the safety of the economy.” Finance Minister Berat Albayrak at the top of the economy administration, upon a related question from Sinan Tavşan from Nikkei, said, “Financial stability is a national security issue;” especially at a time when the top mechanism to defend the Turkish Lira is lira interest rates, which were lowered more than 12 points. 

Last year between January and March, exactly before the local elections, foreign currency sales were conducted through state banks to control the foreign exchange rates and prevent vote loss, the foreign currency public banks sold were provided to these banks from “the back door” of the Central Bank.

Economist Haluk Bürümcekçi scrutinized the foreign currency transactions of the Central Bank and found the traces of “evaporation” worth about 32 billion dollars during the entire year in 2019. In other words, some 32 billion dollars that should have been added to the reserves are nowhere to be found.

Another track of this was apparent since the foreign currency accounts of local economic actors had increased 32 billion dollars. When taken into consideration that in balance of payments, current account balance and capital flows are roughly at par, then it was obvious who sold these 32 billion dollars. It meant, through the hands of state banks, foreign currency that would have been accumulated in the Central Bank were sold. 

When public banks sell foreign currency, it becomes difficult to find a name for Turkey’s foreign exchange rate regime.

Turkey left the fixed exchange rate system and adopted the floating exchange rate regime after the 2001 crisis. The difference between the two regimes is that in the fixed rate system, the Central Bank allows the exchange rate it has determined to sway in the markets with a very low margin, defending the rate level it has fixed through selling foreign currency. The fixed rate regime can be very well maintained in countries with strong foreign currency reserves. Countries such as Saudi Arabia and Qatar are good examples for this.

In year 2000, the “crawling peg” system was adopted, when this did not work out “floating rate” regime was adopted.

In the floating rate regime practiced in Turkey for nearly 20 years, the Central Bank does not guarantee or protect any level. Basic process is that as the rate increases, it curbs the appetite to buy foreign currency, suppresses the demand for foreign currency. For this reason, if the rate increases too much at a short time, certain economic units find this level too expensive to buy foreign currency, other economy units may find it desirable to sell it. The market balance is achieved through price swings. Central Bank does not supply foreign currency to the market except for short term foreign currency liquidity anomalies. The Central Bank can sell foreign currency through tenders at market rates. The aim of this is to relax foreign currency liquidity squeeze. This does not affect the rate level in the long term.

Even though its name is “floating exchange rate regime,” the current one can only be called “commanded foreign exchange regime.” Some may object to that and suggest “managed floating rate regime.” If it was the latter, then the Central Bank would have openly done it. Everybody would have been informed of a rate regime which has targets, a framework and a system. But we do not know anything about this “dystopian regime.” 

What good is it to sell the market foreign currency for 24 hours through several public organs (The Wealth Fund or state banks) when the name is “floating rate regime”? 

For a short time, the target exchange rate could be maintained and the rate would stay withing a narrow band. However, because relative prices are disrupted, movements of wealth and capital would rapidly erode Central Bank reserves.

The perspective in Ankara saying, “We should have control of exchange rates for economic safety” is a shallow one. This viewpoint would lead the country to a real economic safety gap.

A significant part of the reserves of the Central Bank are reserves that are created with debt.

The foreign currency reserve spent to keep the exchange rate at a narrow band will create a gap in economic safety in a process when the country really needs it. 

The sanctions bill is at the brink of becoming a law at the US Senate. If this bill passes, then these reserves would become the much-needed foreign exchange reserves. Spending them for the sake of holding the rate at a narrow band is mind boggling.

Why, then, is there an effort to keep the exchange rate at a narrow band through eroding foreign currency reserves? It was to lower interest rates 10 to 12 points. Well, this has been done. 

As the Central Bank lowered interest rates with the orders of the President, public banks were on duty 24 hours to be able to cling to the story of “Look, nothing happened to the exchange rate.” 

It is being told that those teams that sold foreign currency in public banks called themselves “the national squad.”

So much so that, since it is known than an exchange rate hike will follow an interest rate cut, at those moments when the Central Bank was announcing a cut in interest rates, additional foreign currency was sold at the markets, lowering the exchange rate. A “false paradise” is presented to the public by headlines saying, “Both the interest rate and the exchange rate have fallen.”

Selling of foreign currency through state banks created quiet a gain for foreign investors who had brought their money into the country before. You know, the ones that the government claim as “those foreign powers that want to destroy us.” Foreign investors who one way or another were not able to sell their stocks or bonds in Turkish Liras and could not leave the country had the opportunity to transfer their money through buying foreign exchange from a very narrow band rate. They were able to leave by “skipping over a low-level bar” as if they were given an “exchange rate guarantee.”

While the economy management provided, through public banks, that the dollar exchange rate stayed between 5.70 and 5.85 range in the period of September – mid-December, they abandoned this and put the new range at 5.85 and 5.95 band from mid-December to beginning of February. According to Banking Regulation and Supervision Agency (BDDK) data, public banks have opened their foreign exchange positions 4 billion dollars in the two-weekly period of December 13 and January 3. In other words, they have sold foreign currency.  

In the last 10 days, it was observed that the dollar exchange rate was held at 5.98 no matter what happened in Turkey or in the world. On Friday, when demand to buy dollar peaked, the rate exceeded the 6 lira level. 

Private bank executives estimate that public banks have sold nearly 3 billion dollars on Friday.  

According to Central Bank data, non-residents have sold assets worth 6.6 billion dollars in the last 12 months, with 5.5 billion dollars of bonds, 1.1 billion dollars of stocks. While the drop in interest rates of the Central Bank pushed bond prices upward, the exchange rate level was put on a narrow band, thus resulting in a relatively cheap foreign currency, prompting capital exit.

Public banks compete with private banks while they are offering normal banking services, but at the same time with the assignment of defending the foreign exchange rate they have a “superiority of insider information.” 

They know to what level and up to where the rate level would be defended, but they compete with private banks under “equal rules.” If one looks for anything against competition rules, these matters public banks are involved in would be in text books as examples of distortion of competition.

As a matter of fact, it can be observed that foreign banks are slowly packing their bags and saying farewell to the Turkish banking system. According to Reuters, the other week, HSBC made plans to leave Turkey and last week it decreased its share in Yapı Kredi by selling its Unicredit shares.   

While institutions and rules are undermined, Turkey is rapidly moving away from free market economy. The outcome of this is a remarkable loss of welfare.

Let us see whether the people in Turkey will consent this situation blatantly approaching us.

My opinion is that they will not.

September 10, 2021 Central Bank's Beştepe problem