Turkey's central bank sold $1.3 billion on Wednesday to prop up the lira as foreign capital that had flooded in earlier this year continued to flee on fears over U.S. monetary policy and domestic political uncertainties.
The move was the second heavy day of intervention this week after a record $2.25 billion was thrown at the lira on Monday, bringing total sales for the year to $6.2 billion. The lira has fallen almost nine percent against the dollar since May.
The credit rating agency Fitch said any prolonged unrest, following two weeks of protests against Prime Minister Tayyip Erdogan last month, could put at risk the sovereign investment grade rating that Turkey achieved in November.
Turkey's banking watchdog, reflecting concern over the recent strong market movements, said it had launched an investigation into this week's foreign exchange deals.
Erdogan has made clear his opposition to interest rate rises to stem currency outflows, but analysts said foreign exchange intervention alone would have only a limited effect.
Turkey's total net reserves, according to bankers' calculations, are now below $40 billion. HSBC strategist Murat Toprak estimated that Turkey could afford to spend about $10-$13 billion of its reserves in defense of the currency.
“The market is questioning what is going to be the monetary policy option. Their next move should be to hike interest rates, and I expect them to hike the lending rate, the upper end of the corridor,” he said. “But they always use the interest rate tool as the last resort, which they use when they have nothing else left.”
Emerging currencies have plunged to multi-year or even record lows against the resurgent dollar. This is forcing many central banks to rally to their defense on fears that currency weakness will lead to a wholesale exodus of foreign capital.
Turkey, whose economy has grown rapidly since Erdogan came to power 10 years ago, seems to have taken the heaviest hit, undermined by unprecedented protests last month that Erdogan, in the eyes of markets and critics at home, handled badly.
The lira weakened to a record low of 1.9737 per dollar early on Monday before the central bank stepped in. Although the record intervention lifted the currency almost two percent through Tuesday, renewed pressure saw it slide back to 1.9590 per dollar by late Wednesday, even after fresh central bank action.
“At the moment they are just trying to stabilize the currency but I don't think it will be effective,” said Claire Dissaux, head of global economics and strategy at Millennium Global Investments in London. “They are intervening, but there is pressure on them to raise interest rates."
“If you look at their current account deficit and the amount of [maturing] short-term debt and amortizations as a share of currency reserves and compare with other emerging markets, Turkey is the worst,” she added.
However, Erdogan, keen to boost sluggish growth, has made his opposition to rate rises clear, and rattled markets last month, at the height of the protests, by accusing an “interest rate lobby” of conspiring with foreigners to hurt the economy.
This reference was taken by markets as marking a possible change in Erdogan's favorable stance towards business.
Senior banking sources told Reuters the BDDK banking watchdog was seeking details of currency transactions made on Monday and Tuesday.
They said the BDDK had written to banks on Tuesday asking them to detail auction bids and explain the purpose of their foreign currency buying.
“They sought all information on when forex was bought, at what level and by whom on all transactions of more than $2 million,” said one bank executive familiar with the matter.
The regulator told Reuters in a statement that this was routine practice.
Marco Santamaria, Emerging Market Portfolio Manager at AllianceBernstein in New York, said the Turkish central bank was under severe pressure.
“The central bank is losing reserves, they have to finance a substantial current account deficit, and they are dependent on portfolio flows. Now global sentiment has changed and the domestic situation is not helping at all,” he said.
“On top of that, the government is saber-rattling about the 'interest rate lobby' and, as a result, the central bank is constrained in its ability to hike rates aggressively.” he added.
Two-year Turkish local debt yields were up more than 100 basis points at one time, smashing through the key nine percent barrier to their highest level in over a year. Turkey's hard currency debt spread widened 11 basis points on JP Morgan's EMBI Global index, to 272 over U.S. Treasuries.
Turkish stocks dropped more than two percent to 2-1/2-week lows before trimming some losses to stand 1.7 percent down on the day.
The Fitch ratings agency said increased expectations of a U.S. Federal Reserve exit from asset-buying quantitative easing, coupled with the protests, had exposed Turkey's chief weakness.
“A current account deficit equivalent to 6.8 percent of GDP, over 90 percent of which is funded by portfolio investors. Turkish asset prices have come under strong downward pressure, precipitating a sharp fall in the exchange rate and declining international reserves.
“Prolonged social unrest, poorly handled, could deter tourism, exacerbate short-term capital outflows, drive up inflation and damage economic growth, potentially putting Turkey's sovereign rating at risk.”