Seeking a remedy from the 70s model policy toolkit

Turkey woke up in the morning of May 23, which happened to be the eve of religious holiday Eid el-fitr, to a Presidential decree. It was about the rise in the tax rate imposed on transactions involving foreign currency sales from 2 per thousand to 1 percent, a fivefold increase. Separately, witholding tax rate on gains from commercial papers issued by banks with maturity less than one year term have been increased from 10 percent to 15 percent.

The 1 percent tax to be levied on foreign currency sales is quite high. In economic language, this is called “Tobin tax.” This is some sort of a capital control or foreign exchange control practice. However, those who impose it do not call it “capital control.” When they do not call it this, it does not mean that it does not fall into the same category. 

“Tobin tax” was first suggested in 1972 by Nobel Economy Prize winner (1981) James Tobin when Bretton Woods system collapsed. In this system, dollar was indexed to gold, and other currencies were indexed to the value of dollar, but the fixed exchange rate system collapsed and fluctuation started in currencies. It was suggested for stability. 

Ankara thinks it can obtain stability for its national money through the sale of foreign currency from the “back door,” which actually rapidly erodes reserves. Ankara has also resorted to banning Turkish Lira to foreigners and other restrictions on foreign currency, but these are actually some 50 year old tools from the 70s. 

This means that Turkey has resorted to a new method which was not even used in the “old Turkey” of those days when during the fixed exchange rate regime when the tax was never above 1 per thousand. 

Even the rate Tobin suggested was at a much lower level when he said, “Let’s say 5 per thousand.” 

In a period when loss of confidence is triggered through awkward practices, the economy management in Ankara, leaves no ground left to protect the Turkish lira when it rapidly lowers the lira interest rate and brings it to a negative real interest.

They are now clinging on to doing make up to the balance sheet by borrowing other countries’ currencies by swap, so that they try to protect the Turkish Lira. They are also opting for a 70s model tax such as the Tobin tax. 

The recent practices of imposing tax on those who buy foreign currency, the rule of “delivery the next day” in foreign currency purchases, the unlawful tight rein on banks are increasingly creating uneasiness for the saver. When “soft” tools for capital control have been started to be used, then individuals and companies that make up the economic units start asking, “Are the hard ones to follow these soft ones?”  

As a matter of fact, as it happened in 2018 after the Brunson crisis, also after the COVID-19 crisis broke, the erosion in foreign currency accounts became remarkable. This erosion is not because of converting foreign currency to Turkish Liras. For instance, the drop in the foreign currency accounts in August 2018 and March 2020 is parallel with the drop in the foreign exchange banknotes vaults of the Central Bank. 

While Ankara creates uneasiness for the savers this way or that way, it feeds exits from the system and supports purchases of gold. 

The “demonizing” of those who buy foreign currency makes citizens and institutions, that want to protect their financial assets when under bad management, direct toward keeping gold. 

The drop in foreign currency accounts, only with the start of the Covid-19 pandemic, from March 6 to May 15, is 10 billion dollars. The rise in gold accounts is 4 billion dollars (almost 60 tons.) in the same period. In total, as a result, foreign currency type accounts have a 6 billion dollar drop. (Central Bank data) 

One of the waves that these steps toward capital control will bring is the formation of a “parallel market” in the foreign currency market. What we used to have domestically, which was called “mobile FX market” - which was unregistered foreign currency sales and purchases – will inevitably be reborn. It is inevitable because the exchange rates that the banks quote for a couple of kurushes (cents) will now have an additional cost of 7 kurushes with the 1 percent tax. In other words, an institution that would buy dollars from a rate of 6.80, if it sells it without any profit at the same rate 6.80, it will pay 6.8 kurush tax. Its cost to the buyer will be 6.8680. 

Thus, even if there will not be any taxes levied on transactions between banks, the final client will have an extra cost of nearly 7 kurush in sales. For this reason, the margins of sales and purchases will inevitably widen. This, in turn, will shallow the market.  

Another factor is that when domestic purchases of foreign currency for buyers are made more difficult through extraordinary methods and high taxes, this will eventually bring the formation of an “off shore” market. When the exchange rate is different domestically and internationally, then your currency is at another league where the convertibility is wounded.  

All of these efforts using wrong methods to curb the foreign exchange rate will decrease the entry of foreign currency to the system in Turkey. In those places where either soft or severe capital control exists, from exporters and tourism investors to citizens and companies, all economic units adopt the tendency to keep the foreign currency outside without having it enter the system. This makes a more problematic situation and time.   

If you have an advisor, a technical expert group and decision-makers who do not know what would happen if you take these steps, then they are plotting against you. 

The desperate economy management that has damaged the convertibility that Turkey obtained for its currency in the past 30 years, is now relying on a tool box that belongs to the 70s. These desperate steps are pushing the entire economy into an even tougher path.