Turkish investors flee FX-protected deposits, seek safety in dollar accounts

Turkish investors have begun pulling out of the foreign exchange-protected deposit tool (KKM) as they move their funds into regular dollar accounts, resulting in mounting pressure on the country's central bank to meet the escalating demand for foreign currency, Bloomberg reported on Thursday.

Depositors have reportedly withdrawn approximately $5 billion from KKM accounts in the past week, according to an undisclosed source familiar with the matter. The KKM accounts were initially introduced to curb the plummeting value of the lira in the wake of a currency crisis in 2021.

These developments transpired following a series of measures introduced by the monetary authority to facilitate commercial banks in facilitating their clients' exit from the KKM program. The shift in strategy is part of a broader shift in monetary policy after President Recep Tayyip Erdogan secured re-election in May. The new administration aims to phase out unconventional policies, including extremely low borrowing costs, which were previously endorsed by Erdogan. These policies led to a surge in inflation and drove foreign investors away from Turkish markets.

The KKM accounts offered investors attractive interest rates to retain their holdings in lira while providing compensation for any depreciation. However, the recent wave of withdrawals is indicative of a growing lack of faith in the lira's stability. A majority of the $5 billion outflow reportedly originated from investors who had initially held dollar savings but reverted to regular dollar accounts over the past week. The withdrawals from KKM accounts have prompted concerns about the central bank's ability to handle the elevated demand for foreign exchange.

Although a smaller portion of retail investors' lira savings entered the KKM program during the same period, this trend managed to offset the net weekly drop to slightly under $5 billion. The situation presents a significant shift, marking the first instance of such a change since January.

The central bank has refrained from providing any official comments on the ongoing situation. However, experts anticipate that official data scheduled for release later this week will shed light on the remaining funds within the KKM program.

The substantial outflows from the KKM program in recent days have resulted in an unusually high demand for foreign currency from commercial lenders. To meet this demand, the central bank has tapped into its reserves. This strategy has had a minor impact on the monetary authority's net reserves, although the overall change in gross foreign exchange holdings has been relatively minimal. The limited impact on gross foreign exchange holdings can be attributed to increased swap transactions between the central bank and commercial lenders, as indicated by the undisclosed source.

Last month, Hafize Gaye Erkan, the governor of the central bank, announced that the institution had ceased using its reserves to prop up the national currency. Despite this, the central bank has still been able to address banks' demand for dollars arising from outflows from the KKM program.

Initially perceived as a lifeline for the lira, the foreign exchange-protected deposit tool attracted over $120 billion in inflows. However, it has since evolved into a costly instrument for the government. Both Governor Erkan and Finance Minister Mehmet Simsek view the KKM program as an obstacle to achieving a more normalized monetary policy.

Since the program's inception nearly 20 months ago, the lira has experienced a decline of just over 50% against the US dollar. This dramatic loss in value underscores the challenges that Turkey's central bank and policymakers continue to grapple with in their efforts to stabilize the currency and promote economic growth.