(Bloomberg) — Turkey’s President Recep Tayyip Erdogan announced an emergency plan to curb the lira’s unprecedented depreciation and protect investors against wild swings. One measure would guarantee that returns on lira-denominated deposits wouldn’t fall short of bank interest rates, in an effort to end current spot demand for foreign exchange.
1. How does the new tool work?
The Treasury will make up for losses incurred by holders of lira deposits should the lira’s declines against hard currencies exceed bank interest rates. For example, if banks pay 15% for one-year lira deposits but the lira depreciates 20% against the dollar in the same period, the Treasury — i.e., taxpayers — would pay deposit-holders the differential. Only new retail accounts will be able to benefit from the program, according to Turkish Banks Association chief Alpaslan Cakar, and there is likely to be a minimum maturity for the payment to be made.
2. How is it going to help the lira to appreciate?
If people who hold deposits in hard currencies decide to switch to the lira, that may help the Turkish currency curb its losses. More than half of all deposits in the Turkish banking system are in hard currencies, according to banking watchdog data. Yet because the average maturity of foreign-currency accounts is only several weeks, it is unlikely that they will be converted en masse into new lira deposits.
3. What does it mean for inflation and public finances?
Potentially, the Treasury takes on foreign-currency risk of 3.3 trillion liras ($265 billion) now deposited in retail banking accounts. If the lira depreciates beyond deposit rates, that would burden the budget. If the central bank prints money to make up the difference, then inflation would spike.
4. Does this plan address the crux of the problem?
While the worst may be over for the lira for now, restoring some confidence of retail depositors, “until interest rates provide a credible anchor against inflation, the lira will tend to be volatile and subject to downward pressure,” said Todd Schubert, head of fixed-income research at Bank of Singapore Ltd. Much will also depend on whether depositors believe the policy can actually be implemented, according to Brendan McKenna, a currency strategist at Wells Fargo in New York. “Right now, Turkish institutions don’t have a ton of credibility, so there may be challenges getting lira depositors on board,” McKenna said.
5. What could cause it to fall apart?
Details of the new tool will be crucial, and are to be released at 2 p.m. local time on Tuesday by Treasury and Finance Minister Nureddin Nebati. If the new instrument fails, then the Treasury would have to find the money to compensate holders of lira deposits for their losses. The central bank, in turn, will likely print money, further undermining the lira, according to Wolfango Piccoli, the co-president of the Teneo consultancy. And if the new tool manages to stabilize the lira, the real exchange rate will rise, undermining the supposed competitiveness from a weaker currency that is key to boosting Turkey’s exports, a pillar of the government’s new economic model, he said.
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