One is for sure: Turkey never disappoints, not even before the Christmas holiday season. After the announcement from president Erdogan on Monday evening more details were revealed regarding the new instruments and the market showed a first signal of how the new tools were perceived: positiv. The Turkish lira was trading around 12-lira levels against the US dollar (after the peak of 16.4 on Monday) and the euro is around 14-lira levels. Overall, the lira gained around 20%. For now at least. It is still not clear if this positive development will continue next year. Now, let us first look at the most relevant fresh facts and try to find similar past cases.
What does "Turkish Dollar" mean?
In the media the term "Turk dolar" (Engl. for Turkish Dollar) is used to describe the new foreign exchange (FX) denominated investment tool. As explained yesterday, the key idea behind this tool is the guarantee that the Turkish Treasury will pay the same return as FX markets for Turkish lira savings. The Turkish Finance Minister Nureddin Nebati later stated that this new instrument will have 3, 6, 9 and 12 month maturity term options. If investors withdraw earlier their savings will be denominated to lower FX rates. A kind of incentive not to do it. This de-dollarisation tool has so far helped to spike a huge interest to buy lira. But it also has risen several concerns. First, the tool would increase the public debt as the treasury is paying for the FX difference and second, inflation could rise even further as more lira is injected into the markets. However, Turkey could succeed to de-dollarise* the economy as several countries show who have struggled with the same economic problem and implemented various measures to fight it.
What similar de-dollarisation instrument been applied before?
According to a Turkish journalist, Ragip Soylu, a similar approach has been adopted in Turkey in the 1970s. The so-called "Convertible Turkish Lira Deposits" (CTLDs) guaranteed to cover for all forms of risks linked to currency devaluations for payments made in these deposits. The program ended in 1978 which led before to increased credit explosion, higher inflation and a bigger pile of public debt. The goal for CTLDs was to attract foreign money, whereas now, the situation is completely different: Turkey wants to free itself from the dependency on foreign capital flows. Looking at the past, several countries used other tools to "de-dollarise" their economy, including multiple Latin American countries and Israel. A paper from 2007 and a study from 2005 look at these countries that have experienced intensive dollarisation, their coping mechanisms and consequences. In summary: each country used a different tool and the success depends often on multiple other macroeconomic factors. Israel's case was successful for instance. What did the government do? Israel "imposed a mandatory holding period for dollar deposits valued at administrated rates" and Israel banks were required to "hedge currency risks or impose higher collateral in the case of dollar lending to the non-tradable sector". It also implemented other strategies (e.g. inflation target) to win back the credibility in monetary policy and later price stability. Favourable economic conditions and different instruments led to a positive outcome in the late 1980s and 1990s. Chile, Mexico and Brazil were also successful in avoiding dollarisation by imposing strong financial policy tools such as the "prohibition for households to hold dollar deposits". On the other hand, Bolivia and Peru lost the fight against the dollar dependency. By restricting back dollar deposits they caused further macroeconomics instability. What do these past experiences show? That the outcome for Turkey is unclear. The whole economic picture must be assessed.
In my next article, I will look at the overall macroeconomic environment and key financial factors of Turkey to assess whether Turkey's model will succeed or not.
* Dollarisation means in simply, that the local currency is partly or almost fully replaced by the dollar in all its functions (savings, payments etc.). This is usually triggered by uncertainty, political instability or inflation.
** Disclaimer: The views expressed herein are those of the author and do not necessarily reflect those of the Deutsche Bundesbank or of the Eurosystem.
