The forex regime invented by Ankara collapses

For a long time, Ankara had eroded foreign currency reserves worth near 100 billion to hold the rate. Now, it has come to the end of the road. It has spent its last penny and left the rate to the markets. Thus, the “unheard of” invented exchange rate regime has collapsed.

The floating exchange rate regime, because of its flexibility that absorbs shocks enables the monetary policy to function independently. When capital account is unrestricted, it is not possible to control both the interest rates and the exchange rates. With the “presidential system” set up in 2018 in Ankara, the economy management went for a “test” regarding controlling both the foreign exchange rate and the interest rates. Naturally,
this was possible to sustain this for a while by spending the forex reserves.

The only problem is that the economic administration in Ankara assumed “it had succeeded in this,” and continued with extreme self-confidence. We were under a floating foreign exchange regime but a certain forex rate level was to be defended; and when this level was exceeded, again, an upper level was to be defended.

This false rate regime that cannot be called “floating rate regime,” “managed float regime,” or “peg regime" collapsed one day when reserves were about to end.

Train crash in slow motion

The Turkish Lira rapidly depreciated in the past 10 days. This was not a surprise for our readers and those who closely monitor monetary equilibriums.

What had happened so that at the week of August 4 after the Feast of the Sacrifice, (Eid al-adha) foreign exchange rates started climbing and increased 10 percent compared to July 10?

According to Central Bank data, in the period between July 10 and August 7, the amount of total foreign currency and gold assets in the banking system has increased 18.2 billion dollars. More than half of this has occurred in the last two weeks of this 5-week period.

Out of this 18.2 billion dollars increase, roughly 7.5 billion dollars are attributed to gold and the value increase due to the rise of the euro against other currencies. This should not be taken into consideration; whereas, the remaining net 10.7 billion dollars are from the domestic residents’ (individuals and companies) purchase of foreign currency and gold by paying in liras.

Out of this 10.7 billion dollars’ increase, only 4.5 billion dollars alone occurred in the last week, the week of August 7. This is the biggest weekly increase in the past five years.

In these past weeks, we can see the exit of foreign investors worth nearly 1.5 billion dollars.

Thus, in these five weeks, a total of 12.2 billion dollars’ worth of forex demand has entered the market. While foreign currency entries have dried up, the increase in the demand of foreign currency pushed the forex rate upward. As a matter of fact, this was what happened. Despite the fact that public banks sold foreign currency to hold the dollar rate at 6.85.

Apparently, Ankara has reached a point where it is unable to defend the exchange rate through “back door” methods and via public banks. It has dropped defending the exchange rate. For a long time, Ankara had eroded foreign currency reserves worth near 100 billion to hold the rate. Now, it has come to the end of the road. It has spent its last penny and left the rate to the markets. Thus, the “unheard of” invented exchange rate regime has collapsed. In the Grand Bazaar (Kapalıçarşı) foreign exchange market, which has been active all along and which operates through effective exchange trade, revived in parallel, while the official market also revived at a higher rate.

On the other hand of the medallion, the economy administration that spent billions of dollars of foreign currency reserves to hold the forex rate at 6.85 issued statements saying, “foreign powers are making operations on us.” This has been said despite the fact that behind this foreign currency demand is the demand of our true residents and foreigners.

The latter, in fact, had bought the “Turkey story” before but when things started getting out of hand, left. Because all foreign institutions and banks were prevented from receiving liras, the argument of “foreign attack” is no longer valid.

When the climb in the forex rate was not able to be curbed with spending more forex reserves, they let public banks sell foreign currency from the “back door;” at least suspending for a while the defending of the forex rate. This was a sign that the reserves were finished and there will no longer be such a defense of this sort. The forex rate climbed further up. The approximate 5 percent increase came after this pause. When the past one month is taken into consideration, the forex rate has increased almost 10 percent. After the Central Bank stopped giving money below its own policy rate, this climb slightly settled.

Turkey's financial security risked

Minister of Treasury and Finance Berat Albayrak was at CNN Turk news channel after this slight stability, saying the exchange rates will climb and descend. “What is important is not the level of the rate but whether it is competitive or not. For the first time in Turkey’s history, we have obtained a structure that can manage its economy with a competitive rate level. We are saying our currency unit should be more attractive, more competitive for tourists to come, for the exporter.”

When the exchange rate peaked, the politician was explaining to us that “The Turkish Lira has become competitive.” This is the same politician that held the interest rate at a negative real interest rate level to support the excess credit growth in the past year. In order to sustain this, he met the forex demand of residents and foreign investors who were escaping the lira by spending 60 billion dollars of foreign currency reserves (When fresh foreign currency entries are considered, this figure is 100 billion dollars.)

When it was asked in the televised interview why this has been done, the minister said, “The main issue here is at the financial security point, at the economic infrastructure point, whether Turkey is capable of managing these waves in a controlled way.” Waves have been managed for “financial
security.”

The real problem is that to protect the governing party, for it not to lose votes, in other words, for the continuity of the ruling party, our national currency lira has been left defenseless by lowering the interest to negative real interest rate, forex reserves have been eroded to defend exchange levels that have no economic meaning. Precisely through this method, Turkey’s economic and financial security has been risked.

The point for the country to hold forex reserves is to maintain “contingency reserves;” first to keep the country’s economy running in state of emergencies and to be able to import. This has been spent.

Not foreign powers, citizens 

After the presidential system formed following the June 2018 elections, the administration adopted an adventurous road in economy. In the one and a half years since the beginning of 2019, resident citizens and companies have an increase of roughly 50 billion dollars in their forex accounts. When the exit of foreign investors worth 15.5 billion dollars is added to this, the demand for foreign currency was 65.5 billion dollars.

This new management style was not able to present a macroeconomic program framework, moreover, it has deepened existing issues and gaps. The demand of 65.5 billion dollars that surfaced in one and a half years only in these two zones is the result of these imbalances and distrust.

Instead of solving this main issue and imbalances, the “extinction” efforts toward the symptoms was adopted thinking it was a policy. Even though the forex reserves of the Central Bank has been spent to the last penny and the forex rate was trying to be curbed, in this one and a half year period the exchange rate has increased 40 percent, in other words, the Turkish Lira has lost nearly 30 percent of its value.

The explanation given to us at the end of this is that “The Turkish Lira has reached a competitive level.” Well then, why was the reserve of 60 billion dollars wasted? This is the photograph of incoherent and frameless policies: Erode the reserves to defend the foreign exchange rate, when this does not work, tell people “we wanted a competitive rate anyway.”

In 1994, the prime minister of the time, Tansu Çiller, led the country into an economic crisis just to make a couple of points of interest rate cut, causing an exchange rate climb of nearly 130 percent, 150 percent increase in inflation, the ascend of interest rates to 400 percent and an economic stagnation. In an interview with late Mehmet Ali Birand in 2001, she mentioned that this was done to “boost the exports.”

However, after 26 years, this time there is a difference: Turkey’s companies are excessively indebted and a major portion of this is in foreign currency. Turkey, in the hands of inadequate, populist and arrogant politicians who expect different results by doing the same things, could not save itself from losing what it gained up to now. The price, on the other hand, is paid by the society.

November 10, 2020 This is a governance crisis