Saddening news from Syria and the critical decisions ahead…

Last week I wrote an article about the near past of the Middle East, hoping that we’ll not get too much worried about Syria. But, here we are again, devastated by news about Turkish soldiers who were killed in the area.

Before I heard the tragic news, I was in Antalya to deliver two conferences where I had decided to write an article about BDDK (Banking Regulation and Supervision Agency of Turkey)’s recent actions and volatility in FX rates. I am still badly shaken by the incident so I’ll try to keep this as brief as possible. In the upcoming hours, we’ll see what Turkey will do, except the immediate military response it delivered following the attack. Let’s now change the subject.

FX rates were affected by a sudden movement on early Monday morning. While people were discussing numerous scenarios which might have caused this precipitate fluctuation, I decided to focus my attention on an entirely different point.

I made a habit of looking at the position of the “currency basket” whenever exchange rates are affected by sudden instability, because, TRY’s value can change sometimes depending on the course of Euro/Dollar parity, in which case currency basket usually tends to remain unchanged but those who had made nonsense comments in the excitement of USD/TRY’s upward or downward movements can later get embarrassed by the things they said before.

When we look back, we can see that it was in September 3rd, 2018 when currency basket reached a peak level of 7.10. After that, it has fallen back to 5.62, gradually declining over the past year. This is a pretty sharp fall indeed. But let’s remember that the currency basket used to stand at 3.70 in 2017 before it started to increase and finally hit 7.10.

“Let’s keep a calm and open mind before making any critical decisions…”

The interest rates used to remain somewhere between 11% and 12% in September 2017 before exchange rates started their sharp upward trend. Even the banks were calling the CEOs, trying to sell loans to their companies. During that time, some customers applied for loans even though they didn’t need one and had the banks offer them half or one point higher deposit interest rates. Then, things have suddenly started to fall apart, resulting in an almost 100% rise in exchange rates while pushing interest rates down to a band of 35-40%.

Today, the currency basket is nowhere near these levels. But, what happens if it basket is hit by a sudden movement of ascent now? I just hope it doesn’t come to but I have often said during the previous periods of upward trends, “We’ll once again swim in unfamiliar waters”. But this time, there are other parameters involved.

Before, CBRT didn’t use the full potential of monetary and capital markets’ instruments to bring the exchange rates under control. The Fiscal Policies had had enough room to help Turkey’s GDP growth and interest rates had gone down quite organically.

But now, Turkey’s Fiscal Policy seems incapable of contributing to growth. Banks are offering negative real profits and all available resources are being used to control exchange rates. The SWAP rules that have been amended just yesterday are a perfect example of the current situation in Turkey.

Therefore, the fact that currency basket is moving towards 6.30 should not cause panic. But, if we take all the wrong steps regarding the correlation between interest rates and inflation, we might unintentionally ignite a new upward trend which will worsen Turkey’s already fragile economy. So, it is of utmost important that the interest rates decision of February 19 must be well thought out and as comprehensible as possible.

Obviously, Turkey’s response to Syrian regime forces’ strike targeting Turkish troops would set course for markets.

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