Turkish Lira Plummets to New Depths Following Banking Regulations Rollback

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Turkey's currency, the lira, experienced further declines today, reaching a new all-time low against the US dollar. This comes as the country's central bank implemented measures to simplify regulations governing banks' holdings and foreign deposits. The move follows last week's significant interest rate hike.

The lira dropped by 1.8 percent, settling at a rate of 25.76 against the dollar, surpassing the previous record low of 25.74 set just last week. The currency has already witnessed a 27 percent decline this year, largely attributed to President Tayyip Erdogan's re-election in late May. Since then, Erdogan has been reversing his unorthodox economic policies, which included cutting interest rates despite high inflation.

In recent days, two major steps were taken to address the economic situation. Firstly, the central bank, under the leadership of new Governor Hafize Gaye Erkan, raised interest rates by 650 basis points to 15 percent, a substantial tightening that fell slightly short of market expectations. Secondly, the central bank began rolling back various rules and regulations that had been introduced since 2021, which aimed to manage debt, credit, and forex markets extensively, while also encouraging lira holdings.

The central bank explained that these measures were aimed at promoting market freedom and ensuring stability. As part of these changes, the official gazette revealed that banks' required securities maintenance ratio for their foreign currency deposits was reduced from 10 percent to 5 percent. Additionally, the range of securities that banks must maintain for their lira deposits now stands between 3 percent and 12 percent, compared to the previous range of 3 percent and 17 percent. The new regulation also requires banks with lira deposits comprising less than 57 percent of their total deposits to hold an additional 7 percentage points of securities, as opposed to the previous requirement of 7 additional points for banks with less than 60 percent lira deposits.

Enver Erkan, Chief Economist at Dinamik Yatirim, expressed optimism about these adjustments, stating that the gradual relaxation of the rules would provide banks with room and time to navigate their bond portfolios, thereby preventing a rapid increase in interest rates. He described the developments as comforting and positive for the sector.

The ongoing decline of the lira reflects the initial steps taken by Turkish President Recep Tayyip Erdogan's economic team to reverse the policies that have contributed to soaring inflation and a mass exodus of investors from the country. However, the measures introduced so far have been gradual. While the recent interest rate hike of 650 basis points was the first in over two years, it fell short of market expectations, resulting in a weaker lira and a drop in Turkish bonds. The current base rate of 15 percent remains significantly below the nearly 40 percent inflation rate.

Ulrich Leuchtmann, the Head of Currency Strategy at Commerzbank AG, commented on the central bank's actions, expressing disappointment and suggesting that more substantial monetary policy changes might be necessary. The depreciation of the lira against the dollar has exceeded 25 percent this year, making it the worst-performing major emerging currency after the Argentine peso. The decline has accelerated since Erdogan's re-election victory, partly due to state lenders reducing their interventions in the currency market, a characteristic of Turkey's recent economic landscape.

Despite the challenges, some foreign investors interpret the lira's depreciation as a sign that the central bank is committed to allowing market forces to determine the currency's value. Moreover, by tightening monetary policy, the bank aims to slow down inflation. Investors are also hopeful that Finance Minister Mehmet Simsek, a former Wall Street bond strategist, will fulfill his promise to implement rational economic policies.

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