October 4, 2011Turkey Moves to Halt Lira's Fall
Istanbul, Turkey's central bank has dug deep into foreign-exchange reserves this week as it attempts to put a floor under the Turkish lira and so head off risks of inflation and capital flight with potential to unravel the country's strong growth performance.
A $350 million auction Friday by the Central Bank of the Republic of Turkey brought the week's interventions to $1.64 billion. At the same time, the bank has cut reserve requirements for commercial banks, pumping liquidity into the financial system.
Turkey's economy grew by more than 10% in the first half of the year. It has a strong banking sector and enjoys low public debt and budget-deficit levels that neighboring European Union economies can only wish for.
Concerns over the falling lira are just the latest in a series of worries some economists have expressed over what lies around the corner for this country of 74 million.
"The central bank's primary concern isn't the value of the lira, but inflation," said Mustafa Akcay, at Moody's economic research, in West Chester , PA. "The lira dropped around 10% in September alone, and this rapid decline creates inflation." The central bank on Thursday raised its year-end inflation forecast to 7.46% from 7.27%, above its 5.5% inflation target. The International Monetary Fund forecast is higher, at 8.5%.
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At the same time the bank has voiced alarm at the impact that a sharp downturn in the EU, Turkey's main trading partner, could have in slowing Turkish growth. Turkey's commercial banks borrow heavily in foreign currency, so the lira's depreciation has put pressure on these borrowers. The bank's reversal this week of raises it made previously to commercial bank reserve requirements appeared designed to add cash to the financial system and so stimulate demand, analysts said.
Another concern has been the size of Turkey's current-account deficit—now above 9% of gross domestic product—and the short term nature of the foreign investment flows that finance it. The central bank "is increasingly concerned that a disorderly sell-off in the lira could worsen capital outflows as investors see the currency as a one way bet," said a research note Thursday by Capital Economics, a London-based consultancy.
As the global economy darkens, Turkey's central bank has turned to foreign-currency auctions to stabilize the lira, rather than raise interest rates.
The IMF last month advised the opposite, saying the bank should raise rates and conserve its foreign-exchange reserves. Those reserves provide a cushion against any sudden flight of the short term investment flows, should Turkey then have to cover the current account deficit.
"We don't waste our reserves … but they are not for decoration on our balance sheet," said the Turkish central bank's deputy governor, Ibrahim Turhan, interviewed Thursday on the margins of the Global Economic Symposium in Kiel, Germany. As of October 4, the bank's foreign-exchange reserves stood at $85 billion. The lira was trading at 1.85 to the dollar Friday, down from a peak of just over 1.90 earlier in the week.
The IMF forecasts that Turkey will grow by 2.5% next year, a sharp slowdown from current heady levels, but still well above forecasts for most developed economies. And longer term, rising inflows of foreign investment this year suggest investors are increasingly willing to overlook Turkey's short term risks.
Foreign direct investment in the seven months to July was $9.1 billion, according to Turkey's economy ministry—the same total as for all 12 months of last year. This week saw the launch of a new $1 billion by one U.S.-based private equity fund, Cerberus Capital Management LP, and the unveiling of a $300 million venture in a Turkish private-schools business by another, Carlyle Group.
Investors and Turkish officials point to the country's youthful population—median age 28, compared to 44 for Germany and 37 for the U.S., according to United Nations data—to explain their optimism for longer term growth. Meanwhile a high-profile foreign policy and eye-popping growth rates over the past year have drawn attention.
"It didn't take us a week to get 30 companies to come with us," on a trip to promote investment ties between the U.S. and Turkey, said Thomas J. Donohue, president and chief executive of the U.S. Chamber of Commerce, interviewed in Istanbul Wednesday. He said those companies included Citigroup and General Electric.
"Look what's happening in Europe, in the Middle East," he said, contrasting the debt crisis in Greece and turmoil in Libya with Turkey's relative stability and strong growth.
Other larger deals this year include U.K.-based Diageo PLC's $2.1 billion purchase of Turkish drinks maker Mey Icki. In another $2.1 billion deal last month, Jersey-based Vallares PLC—an investment vehicle run by former BP chief executive Tony Hayward—merged with Turkey's Genel Energy Investment Ltd. Genel has significant oil production in Northern Iraq.
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