Turkey's foreign exchange reserves surge amidst Central Bank policy shift

Turkey's net foreign exchange reserves have experienced a significant surge of nearly $5 billion over the past week, as calculated by prominent bankers, according to Reuters on Wednesday. This positive trajectory is part of a larger trend, highlighting the country's efforts to restore economic stability through the adoption of a more orthodox monetary policy, particularly following the May elections.

The rebuilding of the central bank's currency buffer not only serves as an indicator of the authorities' willingness to ease controls on the Turkish lira but also signifies a broader shift towards a more disciplined fiscal approach.

This resurgence in reserves comes on the heels of a period of turmoil in Turkey's financial landscape. Following President Tayyip Erdogan's re-election, the Turkish lira had witnessed a steep 26% decline, sparking concerns both domestically and internationally. However, recent weeks have seen the lira hold its ground, thanks to the concerted efforts of the central bank.

The central bank's reserves had experienced a significant decline, reaching a worrying low of minus $5.7 billion in early June. This marked the lowest point since the commencement of data publication in 2002. The decrease was a response to the authorities' attempts to address the high demand for foreign exchange and stabilize the lira throughout the election period. Nevertheless, the central bank's reserves have displayed remarkable resilience, rebounding from the low point and gaining momentum once more.

Bankers' calculations, shared exclusively with Reuters, demonstrated a remarkable increase of $4.9 billion in net reserves, bringing the total to $15.8 billion over the course of the previous week. The aggregate reserves, encompassing various financial assets, also experienced a noteworthy upswing, reaching a total of $115.6 billion. The official data regarding these developments is set to be released by the central bank on Thursday at 2:30 p.m. (1130 GMT).

A pivotal shift in monetary policy is at the heart of this transformative narrative. The central bank, once under the influence of an unorthodox policy spearheaded by President Erdogan, had drastically slashed its benchmark interest rate from 19% in 2021 to an alarming 8.5% in February. This move, despite the prevailing high inflation, had catalyzed a severe lira crisis. However, the recent appointment of Governor Hafize Gaye Erkan marked a turning point. Under her leadership, the central bank exhibited a more prudent approach, raising the interest rate by an impressive 900 basis points within a span of two months.

Despite this positive trajectory, the week leading up to July 28th did experience a temporary reversal, with net foreign exchange reserves declining by $2.8 billion to a level of $10.89 billion. Nevertheless, these fluctuations are being viewed through a broader lens of progress and stability.

One of the notable strategies employed by the central bank to bolster reserves involved purchasing at least 40% of exporters' forex income, amounting to an annual influx of approximately $100 billion. These reserves were subsequently employed to support the lira. However, this practice was suspended following the elections. Nonetheless, the central bank continues to receive foreign exchange through tourism and a safeguarding scheme for lira bank deposits known as KKM.

A senior banker highlighted the ongoing significance of monitoring reserves to ensure a smooth transition from a state-controlled framework. The central bank's gradual approach, combined with its resolute regulatory role in forex markets, contributes to sustained stability. It's important to note that the lira's recent holding pattern around 27.0 to the dollar isn't artificially maintained by state interventions, according to a source familiar with the matter. The central bank only intervenes during extreme volatility, thereby allowing reserves to naturally accumulate.

Looking ahead, the central bank's stance on reserves is poised to play a critical role in shaping Turkey's economic landscape. Particularly, the upcoming month of August is expected to be pivotal, with redemptions amounting to $45-50 billion under the KKM scheme. This scheme, which safeguards lira bank deposits from depreciation, has already seen the central bank pay an estimated 300 billion lira ($11 billion) to cover depreciation costs in the months of June and July. The estimated cost for August is even higher, at 350 billion lira.

The KKM accounts currently hold a substantial amount of money, approximately $116.6 billion, constituting around 3.1 trillion lira. This amounts to roughly a quarter of the total bank deposits in the country, underscoring its significance in maintaining economic stability.