Foreign investors’ interest in Turkish financial markets remains high, as judged by comments in global financial press. However, many of these investors were hesitant to enter the Turkish bond and stock markets due to concerns about the inadequacy of the fight against inflation, the policy rate falling behind the inflation rate, and possible political interventions in the Şimşek team’s orthodox policy implementation.
With just a few days left before the local elections, the hefty interest rate hike gave foreign investors confidence that post-election monetary policy would move in the right direction and that the new economic team would remain in place. This new perception may stimulate foreign inflows that will continue throughout the year, starting from April, and may help the Central Bank of the Republic of Turkey (CBRT) to replenish its depleted reserves. It seems very likely that foreign investors will want to continue the interest rate increase cycle by looking at inflation dynamics, though.
On the other hand, the strategic mistake of the CBRT, which tried to gain control on the exchange rate by melting reserves while watching the pressure on the TL increase, especially in the last month, was not to increase the interest rate by 500 basis points by holding an extraordinary Monetary Policy Committee (MPC) meeting. It is regrettable that such a significant amount of reserves to manage the Turkish lira in the future was lost as a result of not taking similar steps sooner. Considering that the CBRT President and his deputies are educated managers who can understand this reality, it is not easy to think that a process of obtaining political permission remains an indispensable part of monetary policy.
WILL DOMESTIC DEPOSIT HOLDERS CONVERT TO TL INSTEAD OF BUYING FOREIGN CURRENCY?
The most important factor in the increase in the demand for foreign currency and gold is a significant part of the savers who were encouraged to leave Turkey’s currency protected TL deposit scheme (the KKM) think the TL deposit interest is far the current inflation level.
1-3 month deposit rates, which are around 50% compared to 67% current CPI inflation, provide no incentive for domestic investors to return to TL. The CBRT, which increased the policy rate to 50% (compounded 63.2%) in its March meeting, may still not seem attractive enough for savers who are probably eyeing a level of around 75% before trusting TL assets. Accompanied by the crisis of confidence created by the presidential system, conservative savers may demand a higher risk premium, that is, interest level, in order to convert from foreign currency to TL.
In short, for domestic savers, verifying that inflation declines from its expected peak after May 2024, CBRT reserve increase and the continuation of strong TL policy are the necessary factors for behavioral change. Additionally, remaining skeptics will need to make sure Erdogan does not step back from orthodox economic policy for one reason or other after next week’s local elections. At the end, it is not impossible for dollarization to soften and reverse, but it will happen gradually and with significant hesitation.
Guldem Atabay, economist and consultant
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