The Turkish lira fell yesterday, for a third day, after the central bank announced that it would shift its policy focus to core inflation, fueling speculation of an interest rate cut.
Yesterday, the Governor of the Central Bank of Turkey, Shihab Kavcioglu, stressed the importance of focusing on the role of “basic prices” when looking at monetary policy.
The lira fell 0.5 percent to 8.5188 pounds per dollar, recording the largest decline among emerging market currencies. Bonds and local stocks also fell.
He said, “Exceptional circumstances, especially caused by the pandemic, increase the importance of the basic inflation indicators.”
He added: “Across the world, when the monetary policy stance is determined, fundamental indicators, which do not include transient factors resulting from matters outside the influence of monetary policy, are taken as a basis.”
General inflation in Turkey continued to rise for the third month in August to 19.25 percent on an annual basis, compared to 18.95 percent in July.
On the other hand, the core inflation index showed that, apart from volatile items such as food and energy, prices fell on an annual basis to 16.76 percent compared to 17.22 percent in the previous month. The central bank has kept the key rate at 19 percent since March.
This comes at a time when Turkey’s foreign trade deficit rose 51.3 percent year on year in July to $4.278 billion, according to the General Trade System.
The Turkish Statistical Institute recently said that after the damage to trade a year ago due to the Corona pandemic, Turkey’s exports rose 10.2 percent to 16.41 billion dollars during July, and imports increased 16.8 percent to 20.69 billion dollars, compared to the corresponding period 2020.
Turkey did not necessarily benefit from lower lending costs. With the increase in state risks and the deterioration of banks’ balance sheets, it has become more difficult to borrow in foreign currencies abroad. As foreign-exchange reserves were sold through banks to tame devaluation, and households increased their foreign-currency deposits in response to rising inflation, foreign-currency mismatches quickly grew on banks’ balance sheets.
The shift to the dollar gained more weight as the pandemic continued, with local residents’ deposits in foreign currencies accelerating, especially in early August of last year, which led to an increase in banks’ foreign currency commitments to local families.
Banks cannot reduce their foreign-currency debt immediately, because they need to repay or carry over existing huge obligations. Although foreign-currency loans are cheaper, Turkish companies fear that they will have to struggle to generate enough foreign-currency revenue to repay them.
To reduce the foreign currency mismatch, state banks should either increase their foreign currency loans to companies, thus stabilizing the asset side, or reduce their foreign currency borrowing from both domestic households and creditors abroad – stabilizing the liabilities side.
Thus, it will be difficult for banks to improve their position, in terms of foreign currencies, while continuing to sell reserves to support the lira.