Going Cold Turkey?

Just an update to all on the rabbit that Erdogan pulled out of the hat yesterday with the announcement on the new FX-linked deposit scheme (DCM).

So under this scheme, depositors will be compensated for any FX depreciation that goes beyond the deposit rate on TRY deposits. In affect TRY depositors are being given a free call option on TRY deposits.

First, the positives:

(+) We finally understood that the Erdogan administration cares about the exchange rate, and has avoided capital controls. Erdogan affirmed that he believes in markets, albeit not interest rates.

(+) It felt as though we were at the start of  bank run this week, so this move should hopefully stabilise the deposit base. For the time-being.

(+) Hopefully the lira should have something of a more solid feel to it, albeit note the 30%+ depreciation prior this month is already baked into inflation.

Second the un-knowns:

(?) We don’t know very much about the new programme. We don’t know its size or scope. There have been suggestions that it might be limited to 6m or 1Y lock-ins, which would limit the fiscal cost, but likely disappoint depositors.

Now the negatives:

(-) This is still bad policy. Its an alternative to what  the CBRT should do, which is raise rates to fight inflation. Nothing here on demand management, this is pre-election pork barrelling.

(-) Actually this programme is still likely to be inflationary, and should be taken in conjunction with other measures announced yesterday including another resurrection of the Credit Guarantee scheme. Banks likely now will reduce deposit rates, and use their cheaper financing to re-expand credit. We have also seen a doubling in the minimum wage, and the new deposit scheme likely will expand money supply.

You might argue that the currency is now pegged, but let’s not forget that inflation was 20% in November, and likely will be 30% by year end, at least, given pass thru from the crazy earlier FX move. I would think inflation peaks at 40-50% in H1 2022. Now in the new economic plan the idea is that the cheap lira improves the current account. But benefits of nominal depreciation will still be rapidly eroded by the 50% inflation rate. So I guess the lira does weaken still in 2022, maybe not in real terms, but nominally I could still see 30% from current levels. This will bake in still a devaluation/inflation spiral. Add in the fiscal stimulus pre-election, and inflation has to result.

(-) Arguably this is just fully dollarizing the deposit base. Its either going to be in FX or now FX linked. And interestingly it also kind of dollarizing the sovereign balance sheet which is picking up the tab for the new scheme. With TRY2 trillion in TRY deposits, the scheme likely costs the budget 1.5% of GDP for each 10% devaluation beyond the 14% deposit rate. This could easily double the budget deficit in 2022. The sovereign balance sheet is taking the FX risk, which comes at a time when a larger share of public debt is now in FX, something like 60% as opposed to a third a decade ago. LT this is bad.

This scheme likely has bought time and avoided an immediate crash in the banking sector but it has done nothing to fight inflation, will further extend Erdogan’s unorthodox interest rate policy and likely puts off early elections and increases the chances of an Erdogan win. Some in the market had seen a change of administration at those elections as a positive, is that more or less likely now?

Note that Turkey ran a similar DCM policy in the 1970s, and it did not result in many positives, actually just accentuated the boom/bust credit cycle.

Economic Boom and Debt Crisis, 1973-77 (nber.org)

Short term, markets are rallying, but does it change the longer term story, 3-6 months out. I don’t think so.