Why are rates rising?
Because the country has too many high-level risks. These risks are; It is present in almost every area, from problems with neighbors to the problem of judicial independence, from attacks on the independence of the central bank to bad interest policy, from the lack of freedom of thought and expression decline in reserve currencies. Their number and weight increase rather than decrease over time. As a result, the CDS premium, which is used to measure country risk, stands at the 700 level, making Turkey one of the three riskiest economies in the world. So those who want to invest in Turkey give up, the number of those who want to lend decreases, their appetite decreases. Domestic residents, on the other hand, see that the increased risk in the economy will eventually increase inflation and that the interest given to TL will not be enough to replace the purchasing power they will lose due to inflation, and they tend to switch to foreign currency. While the supply of foreign currency does not increase sufficiently, exchange rates increase because the demand for foreign currency increases.
What makes inflation go up?
There are two main reasons for inflation: Rising costs (called cost or supply inflation) and demand increasing faster than supply (called demand inflation). two reasons behind the inflation experienced in Turkey. As mentioned above, costs increase due to rising exchange rates. Because Turkey uses a significant amount of imported inputs in production. When the exchange rate increases, the costs of imported inputs, and therefore the costs of production and gradually the selling prices, increase. As the exchange rate increases constantly, this increase becomes continuous and leads to cost inflation. When inflation rises, other cost items including wages, rent and transport costs rise and cost inflation, which begins with the rise in the exchange rate, accelerates by feeding on other posts. Rising inflation, which begins with costs, causes consumers to flee money, buy and store goods, and increase spending under the influence of pulled demand, as the rate of Interest is also less than inflation, and hence demand inflation occurs. As a result, in the negative environment created by high risks, the poor implementation of economic policy, which resulted in the reduction of interest rates, turns into mixed inflation, cost inflation and inflation. mutually feeding demand.
Even if the Central Bank sells so much foreign currency, how does it not run out of foreign currency?
As of May 20, 2022, the Central Bank’s gross reserves are $100.3 billion, including $40.3 billion in gold and $60 billion in foreign currency. $89 billion are borrowed reserves, ie fixed assets of banks in the form of required reserves or deposits with the Central Bank. The remaining $11.4 billion belongs to the Central Bank, this is called net reserves. In addition, Central Bank reserves include borrowed reserves amounting to $63.3 billion through swap transactions. Taking these into account, net reserves excluding swaps are calculated at $52 billion.
Net reserves excluding swaps – $52 billion, although gross reserves are $100.3 billion. In other words, as long as the Central Bank does not return the required reserves to the banks, the banks do not withdraw their foreign currency deposits with the Central Bank, and the foreign currency borrowed against the swap transaction is not not repaid and renewed, the Central Bank has a reserve of 100.3 billion dollars that it can use. On the other hand, the currencies sold by the Central Bank to the market do not disappear either. The Central Bank sells the foreign currencies to the banks, and the banks deposit some of these foreign currencies to those who want to buy foreign currencies. Since no one has contracted loans in foreign currencies during this period, the banks either transfer a significant part of these foreign currencies abroad to be used in the payment of the external debt of their customers, or resell to the Central Bank in order to find liquidity in TL to meet the TL loan request. So when the Central Bank sells foreign currency to the banks, some of it comes back to them after a while, in return, as much TL stays in the market. In addition, 40% of export earnings and foreign currency converted into TL with the exchange-protected deposit application are deposited with the Central Bank and are included in the reserves. However, since imports are greater than exports, more incoming foreign currency is coming out again. Since there is no risk reduction, some currencies go under the pillow and exit the system. The difference between the currencies sold by the Central Bank and those resold by the banks to the Central Bank reduces the reserves of the Central Bank.
To sum up, the Central Bank’s intervention in foreign currency from the reserves works like a kind of sucking and pumping pump which pushes back the water drawn from the same well. However, although additional water is added occasionally, such as a coin-protected deposit, the amount of water in the well decreases as there are increasing leaks with each extraction.
*This article is taken from Mahfi Eğilmez’s personal blog.