What a day yesterday was for the Turkish lira: record loss + super comeback in one day. And the market will now open. But first, let's understand what happened!
What happened before the announcement by the president?
Since the interest rate cuts in September the Turkish lira was on a downward trend and hit almost every day a new record low. Yesterday, on Monday 20 December 2021, the lira was down at around 18.4 against the USD (a fall of more than 11% in one day). The lira was one of the worst performers among its emerging market peers, due to unfavourable monetary policy events over the last two years (e.g., multiple change in the head of the central bank or rate cuts made too early). To stop this downfall the Turkish central bank intervened around five times in December alone - selling around USD 6 billion from its already low foreign reserves, according to Reuters. Despite the efforts the lira did not recover in particular because of the presidents' perspective of freeing Turkey from high interest rates and strong capital inflow fluctuations. The opposite of the widespread economics belief around the globe. On Saturday, even Turkey's largest business group TÜSIAD called the government to get back on the conventional economic model: is the inflation high the interest rate needs to be high. But this will not happen in Turkey. Although the inflation reached 30% last month, the Turkish government has no intention to change the policy rate, instead president Erdogan announced yesterday evening new measures circumventing the interest rate.
What does the new economic package include?
The president announced several measures. One of the key measure is the promise of the government to make up for losses for holders of lira deposits: if the lira's decline against hard currencies (USD) exceeds interest rates the government will pay for the difference in loss (see graph for an example). Another key measure is the reduction of the withholding tax for investments made in the domestic currency from 10% to 0%. The exact details of the implementation are not clear yet and will be communicated soon by the government. For instance, it is still not clear what the role of private and public banks will be in the "currency difference" system. However, a positive reaction could be seen hours after the announcement.
How did the economy react?
Despite markets being closed USD 1 billion was exchanged within hours after the speech by the Turkish president. According to Alpaslan Çakar, the Chairman of the Board of Turkey Bank Association (TBB) and General Manager of Ziraat Bank, private and public banks could be part of the currency difference system for lira deposits. This is due to the fact, that at any given case (of the exchange rate fluctuation) citizens will benefit from the new measure, as in any given outcome they will make a profit (see again the illustration for an example). No matter what, the Treasury will cover for occurring losses. Since banks have nothing to lose in that scenario, Çakar believes, private banks will offer such a financial product for their customers. Moreover, he says that this measurement will affect inflation when the exchange rate returns to its normal course, leading up to lower prices and higher economic growth overall. But it will take some time until the effects start showing up.
What will happen next?
The markets will open later and the Minister of Treasury and Finance will announce more details. Still, many questions remain unanswered, such as market participants reaction or the exact details of the deposit guarantee promise. And most importantly, will this unorthodox measures succeed? 2022 might give some answers.
** Disclaimer: 1. The views expressed herein are those of the author and do not necessarily reflect those of the Deutsche Bundesbank or of the Eurosystem. 2. The information included in the text is based on the Turkish government announcement made on the 20th December 2021. Many points are still not clear, hence, the assumptions made.
