January 10, 2017 / 4:56 PM / a year ago

Turkey's FX war-chest - $100 bln or a third of that?

LONDON, Jan 10 (Reuters) - As the peso plunged last week, Mexico’s central bank dug deep to sell more than $1 billion on Asian, European and U.S. markets. But Turkey, facing a similar currency selloff, lacks the luxury of a war-chest it could raid to stabilise the lira.

With the lira plumbing new record lows to be 2017’s worst performing big emerging currency against the dollar, analysts reckon raising interest rates is the only option for the central bank, but the government is firmly opposed to a move that would harm economic growth.

On the face of it, Turkey’s hard currency reserves look healthy - central bank data showed total reserves of around $106 billion at the end of 2016. But $14 billion of that was gold and a further breakdown of the total figure shows a less rosy picture - especially when contrasted with the amount of external debt that must be repaid in coming months.

Calculations from UBS and other banks in London and Istanbul, based on data from the central bank, estimate the true level of usable reserves at closer to $35 billion.

“Strictly speaking, a lot of the money is not deployable by the central bank ... A lot of it is commercial bank reserves deposited at the central bank,” UBS strategist Manik Narain said.

He calculates that $42 billion is made up of Turkish banks’ mandatory hard currency reserve deposits with the central bank to offset their dollar lending within the country.

And another $16 billion is accounted for by the “reserves option mechanism”, which allows banks to hold part of their lira reserves in hard currency.


“So when the heat turns up, they have to resort to a conventional interest rate defence because by any metric they have among the lowest reserve adequacy levels in emerging markets ... They will inspire a lot of market concern if they deplete reserves too aggressively,” Narain added.

Whether reserves are adequate can be gauged in several ways. One is the number of months of imports the reserves will buy, with three months deemed to be the safe minimum.

Calculations by Bank of America Merrill Lynch (BAML) show Turkey can fund 5.6 months of imports if a reserve level of nearly $100 billion is assumed.

The second method, based on the so-called Guidotti-Greenspan rule, requires reserves to be at least equal to foreign debt payments in the coming year. The rationale is that countries should have sufficient buffers to resist a sudden halt in external financing.

BAML estimated total Turkish external debt at $421 billion, with $107.3 billion due in the coming year. The latter would be more or less on par with headline reserves, but three times more than “usable” levels.

By that yardstick, Turkey’s reserve adequacy would be below that of countries such as Egypt or Ukraine.

Other analysts point out that, while Turkey may not have intervened on currency markets, it has been steadily releasing dollars into the market.

HSBC strategist Murat Toprak said the steady decline in reserves - buffers fell by $6 billion between November-December - should be seen in the light of cuts in banks’ hard currency reserve requirements. The central bank cut the rate again this week, estimating this would inject $1.5 billion.

“So in a way the central bank is using its reserves to inject dollar liquidity into the system,” Toprak said.

“We can’t say for sure they will not intervene in FX markets because of current reserve levels but obviously they have limited ammunition.”

In any case, the effects of currency interventions are usually short-lived. Despite Mexico’s recent huge dollar sale, the peso fell back to record lows on Friday, suggesting Turkey may be better off resorting to a big interest rate rise.

However, President Tayyip Erdogan and his advisers have repeatedly called for lower rates to stimulate economic growth, with some even suggesting that raising borrowing costs would amount to plotting against the state. (Reporting by Sujata Rao; Editing by Gareth Jones)

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