Today’s video is sponsored by the Daily Upside, a totally free, high quality daily
business and finance newsletter.
Visit the link in the description to learn more.
President Erdogan’s government announced extraordinary measures earlier this week to
boost the Turkish lira, including a new savings product designed to protect savings from currency
fluctuations.
These savings schemes are set to be rolled out in a few days and we don’t yet know
how much takeup there will be or what the impact will be on the public finances in Turkey.
The Turkish Lira rose more than 40 per cent against the dollar after the announcement
and has been rallying since.
This is a dramatic change in direction after the exchange rate had hit a record low the
previous day.
Monday was the most volatile day of trading for the lira since the new Turkish lira was
introduced.
The idea of this savings product is that the Turkish Treasury will make up for losses incurred
by savers if the lira’s falls by more than the central banks interest rate against the
dollar over the life of these savings plans.
This investment is available to individuals, but not to businesses and the accounts will
have maturities between three and twelve months.
The minimum interest rate will be the central bank’s benchmark rate and no withholding
tax will be applied.
So, if banks pay 14% for one-year lira deposits but the currency depreciates by more than
that against the dollar in the same period, the Treasury – which really means - the
taxpayer -- would pay deposit-holders the difference.
Let’s take a look at how the scheme works and what it might mean for the Turkish Economy.
So, Turkish savers under this scheme are allowed to lock their money up for a minimum of three
months or a maximum of 12 months.
If you lock your money up for 12 months, you will receive an interest rate of 14 per cent
along with the new government-backed exchange rate guarantee.
In a years time if the lira has stood steady or advanced against the dollar, savers will
receive the 14% interest rate on their savings.
If the lira has fallen by more than 14%, the Turkish government will compensate savers
for the difference, protecting them against the decline of the currency.
The idea is that it will be as if they had converted their savings into US dollars.
There are early withdrawal penalties, where if you take your money out before the agreed
upon date you’ll get no interest, and you’ll get the lowest exchange rate of either the
rate on the day you put your money in, or the rate on the day of the early withdrawal.
This scheme is only available to individuals in Turkey, not businesses.
When announcing the deal, Erdogan said “From now on, none of our citizens will need to
switch their deposits from the Turkish lira to foreign currencies because of their concerns
that the exchange rate fluctuations might wipe out gains from interest payments”.
The idea of this product is to incentivize Turkish people to keep their money in the
lira, instead of either exchanging it for dollars (which would be bad for the exchange
rate) or spending it (which might be inflationary).
Traditionally the way monetary policy works is that when inflation is high and a currency
is falling in value, the central bank raises interest rates.
This high interest rate incentives people to hold your currency – they move their
money into the currency in order to earn the interest.
The higher return on savings equally incentives people to save rather than spend - reducing
inflation.
Very low interest rates – rates below the rate of inflation encourage people to borrow
and spend.
Now, there are a few ways we can think about this savings product, one is as a savings
account with a variable interest rate tied to “however much the currency falls.”
The Turkish government is probably hoping that this will stop Turkish people from selling
the lira and then they won’t actually have to pay out much money.
It is, to a certain extent, a way of raising interest rates without actually saying that
you are raising interest rates – it is a bit funny because it raises rates only for
certain savers, while keeping rates low for borrowers.
Another way of looking at this product is as a sort of currency peg, but (once again)
only for certain retail accounts.
This is a little bit confusing, as usually a currency peg applies to the whole currency,
not just certain accounts.
The way this works is that the central bank will print more lira, the more the lira falls.
Which doesn’t necessarily sound like the best idea.
[Sponsored Content]Now, Before we discuss the economic effects of this new savings product,
let me quickly tell you about today’s video sponsor - The Daily Upside.
If you are struggling to find useful and unbiased financial and business news, the daily Upside
might be the solution to your problem.
The Daily Upside is a totally free daily email newsletter, written by a team of financial
professionals with real industry experience.
It’s become the first thing I read every morning as it is informative, entertaining,
and not dumbed down.
They don’t just give you a generic take, it is the most important news with real analysis.
They had a useful piece a few days ago on how costs are exploding for Turkish farmers.
Whether you are a financial professional or just looking for a great source of business
news, the daily upside will help.
It is totally free to sign up and they send you one information filled email every morning.
I can’t recommend it enough.
Sign up using the link in the description below.
[End of Sponsored Content] OK, so why is this happening in Turkey right
now?
Well there are a few reasons.
The first thing I should point out is that there are no capital controls in Turkey.
In places like China or India, the government can get away with keeping interest rates artificially
low, because they have capital controls in place preventing people from taking their
money out of the country – or out of the currency.
Local citizens are trapped to a certain extent.
The Turkish government can’t do this, because they have a negative current account and a
positive capital account.
What this means is that Turkey imports more than they export, and they finance this by
bringing in funds from abroad.
If Turkey were to put capital controls in place, no foreign exchange would come into
the country.
This is because investors would be aware that if they move money in, they couldn’t get
it back out.
If money stopped coming into Turkey, the country could no longer import goods that they need
like oil and gas for example.
Now, this isn’t a problem for countries like China who are in a very fortunate position
where not only do they export more than they import, but also foreign investors keep pouring
money into the country.
You can only get away with capital controls if you are an export driven economy or if
you are a wealthy country like Switzerland where there is enough money to have investments
outside the country and there is no need to have capital flow in.
I should point out that there is nothing wrong – in general – with Turkey’s situation
of having a negative current account and a positive capital account, you see it very
frequently in growing economies where they need capital to come in and fuel growth.
So, Turkey doesn’t have capital controls, but due to the extreme inflation, the Turkish
economy has become extremely dollarized.
Dollarization is the term for when the U.S. dollar is used in addition to or instead of
the domestic currency of a country.
It usually happens when a country's currency loses its usefulness as a medium of exchange,
due to hyperinflation or instability.
In Turkey, it is easy to open a US dollar account at your local bank, and around 60%
of the banking deposits in Turkey are in US dollars rather than in Turkish lira, additionally
Turks can have accounts denominated in euros and precious metals.
People keep their savings in dollars for stability and most of those dollars then stay within
the banking system in Turkey.
Now, some wealthy people in Turkey might keep their dollars offshore, (we’ll say at Deutsche
Bank in Frankfurt for example), but that would be a small minority.
When Turkish people borrow money, they will often borrow it in Turkish lira, and might
use that to buy a house, a car, or even valuables like gold.
Then, if the currency that they have borrowed depreciates, they benefit from that depreciation.
When you put all of this together, it means that a lot of middle-class Turkish people
– or people with savings and the ability to borrow are essentially short the Turkish
Lira.
Now, it doesn’t appear that a lot of analysis went into this savings product, it was probably
quickly put together last week when the currency was in freefall and the Turkish stock market
was collapsing, but it would appear that the idea is to convince Turkish people to exchange
their dollars for Turkish Lira.
If savers take money out of their dollar denominated accounts and put them in these savings accounts,
they are basically selling dollars to the Turkish government in exchange for a synthetic
dollar – which is what these accounts amount to.
Along with the announcement of the new savings accounts came a Television advert where a
well-known Turkish actor walks a friend through a museum, telling him that the nations flag,
the national language and the parliament represent the country’s pride, and that “the Turkish
lira is our power”.
The goal is to persuade the Turkish people to turn their backs on dollars and gold and
put their savings in lira.
There are a few effects that these accounts might have on the Turkish economy.
Despite what the President says, foreign speculators are generally not short the Turkish lira – one
reason is that it is just much too expensive to borrow, overnight borrow rates are as high
as 300% annualized.
In fact, when you speak to foreign investors, most have no position at all in Turkey, and
most of the banks no longer even produce research on Turkey, as they say that there is no investor
interest.
The problem is not foreign speculators, it is that the people of Turkey have simply lost
faith in the lira as a store of value, because it depreciates so quickly.
Now, given that inflation is expected to be at over 30 per cent in the months ahead, Turks
with access to loans at rates close to the central bank’s policy rate of 14 per cent
still might decide to borrow money to buy real assets or other currencies.
This would be a continuation of the recent trend for Turks to take advantage of cheap
loans to buy other assets, including houses, cars, gold and foreign exchange that would
be expected to go up with inflation.
If inflation is high, they win.
The goal of this savings product appears to be - to convince Turkish people to give up
their dollars in exchange for Turkish Lira and a guarantee.
So, then we have to ask whether the Turkish people will want to do this or not.
If they already own dollars, there is not much of an advantage of tying up your money
like this to get the return you get from owning dollars.
One of the comments on my last piece from a Turkish viewer said that the reason Turks
prefer foreign currency to Lira is that they don’t trust the government’s economic
policies.
The viewer asked, “Why would you hold Erdogan dollars when you can hold real dollars?”
If people do put a lot of money into this product, it then converts inflation risk into
credit risk for the country.
If the Turkish Lira depreciates, the government then has to issue more lira to pay it out
to savers.
The government has taken the exchange rate risk onto its balance sheet with this savings
product.
Up until now the lira depreciating, just caused inflation, but it didn’t harm the countries
balance sheet, and it inflates away local currency debt, but this savings product almost
behaves like foreign currency debt on the countries balance sheet.
If the lira falls in value against the dollar the government owes more and more money.
If you look at Turkish bond yields, you can see the credit spreads widening, this is because,
up until now if the currency fell in value, the only risk for the country was the existing
dollar debt – which was not too big – and this is something that is a big positive for
Turkey.
The more of this product Turkish people buy, the more dollar debt the country finds itself
in.
Another problem with this exchange-rate-indexed interest rate is that the wealthier an individual
is, the more they can participate, and the Turkish taxpayer then find themselves financing
the wealthiest people who can afford to put the most money in.
So why did the lira jump so much when this savings product was announced?
Well, one reason is that this product can be viewed as being an interest rate hike that
is not called an interest rate hike, but another reason is that the Turkish central bank heavily
intervened in the foreign exchange market in order to make it look like the announcement
was having more of an affect than it was really having.
Turkey’s foreign currency reserves fell by around six billion dollars in the first
two days of the week.
The Turkish central bank didn’t announce any official interventions.
But the disappearance of its foreign exchange assets suggests that this played a significant
role in the lira’s recovery.
It would appear that Turkey has spent around 25 billion dollars in the last month trying
to prop up the currency, and the central bank may be entirely out of foreign reserves at
this point.
As I said in my last piece, Turkey actually has a pretty good economy, it is well diversified,
with manufacturing, tourism, trade and services.
It is close to Europe, its biggest trade partner and there are a lot of good companies in the
country.
There is a young educated workforce and levels of household debt are quite low.
This is a much better situation than countries like Argentina and Lebanon who have huge foreign
debts to deal with.
How things work out going forward will be heavily influenced by developments in the
broader global economy.
It was always going to be difficult for countries with more fragile economies like Turkey when
rates started rising in the rest of the world, as those higher rates start to attract capital
back home.
If global rates were to stay low longer than expected, that could help Turkey as their
interest rate policy would not look as bad.
Don’t forget to check out our sponsor The Daily Upside, by clicking on the link in the
description.
It’s a great newsletter that I can firmly recommend.
If you enjoyed this video, you should watch this one next.
Have a great day and talk to you again soon.