Turks are set to sell foreign currency holdings, boost lira

ISTANBUL – Turks are holding onto record amounts of foreign exchange, a traditional response to uncertainty, but if Turkey’s presidential election goes smoothly, they are expected to start selling some of it, strengthening the lira. The lira has risen 13 percent since the end of last year, as risk-hungry investors have bought it to benefit from one of the highest real interest rates in emerging markets. The currency received a boost from the July 22 election victory of the pro-business Justice and Development Party (AKP). But the party now has to elect a president and its official candidate, Foreign Minister Abdullah Gul, could stir tension by irking the secular establishment, including the army. The AKP’s last attempt to elect Gul, an ex-Islamist, ended in political crisis and early parliamentary polls. But the lira keeps firming and investors say if the election this month or next goes smoothly, the lira will rise further. A 25 percent slide in the currency last May and June added to locals’ traditional lack of faith in the lira and Turkish companies, which have increased their levels of foreign debt in the last three years, upped their holdings of foreign currency to make sure they can pay off that debt. Central bank data showed last week that Turks held $90.467 billion in foreign exchange deposits as of July 27, down from a record $91.882 billion a week earlier. At the end of 2005, that figure was $59.8 billion, rising to $75.78 billion at the end of 2006. «With the idea that after the presidential election the political risks will be over and the expectation that the government, having come out of the elections strong and signaling reform, will manage things well, we could go into a reverse currency substitution process,» said Murat Ulgen, economist at HSBC. «The most important risk here is global volatility but until now global volatility has been used as an opportunity to buy lira,» he added. Central bank watched Faced with increased foreign exchange liquidity, the central bank has increased the maximum amount of dollars it buys at its daily auctions and economists said it could further use such instruments to combat continuing strength. «If there is a fast currency substitution process it will create a serious sterilization problem for the central bank,» said Raymond James economist Ozgur Altug, adding it could lengthen the maturity of current instruments or use reverse currency swaps. He sees de-dollarization sending the lira to 1.22 in the midterm, and if that level is broken, then to 1.11. A fast switch by locals into lira could also put pressure on the central bank to cut rates as benchmark borrowing rates of 17.50 percent are the main reason for lira strength. Garanti Bank’s head of economic research, Ali Ihsan Gelberi, said positions were likely to be unwound gradually but, if not, the central bank will likely have to create new instruments. «If the rise (in FX deposits) seen this year is unwound, it won’t cause a problem, but if it goes back to the levels seen before May last year, it could be a problem,» he said. «But if they are unwound quickly, the lira will strengthen quickly and pressure on the bank to cut rates will increase… so the central bank could be forced to create new instruments.»