Weekly Guest Column: Our (Turkey’s) Mighty FX Reserves
The Turkish Central Bank’s intervention in the currency market appears to have shifted to top gear, though the results can be interpreted in a number of ways according to one’s political choice. As the U.S. dollar surpassed 1.90 Turkish Liras on Oct. 5, the Central Bank sold $750 million as part of a package of measures, pulling the rate to below 1.87 in a few hours. According to pro-government Sabah newspaper, the Bank had “pulled down the dollar five kuruş in a single day,” while Radikal joked about a “three-kuruş intervention.”
Yesterday, the bank announced it would sell as much as $1.35 billion, but ended up selling $350 million, facing a massive demand of $2.04 billion. As I wrote this column, the greenback was trading at just above 1.85 lira.
The Central Bank since Aug. 5 has sold $4.32 billion to the market. On that day, the dollar was around 1.74 liras. Considering the desired level of 1.65-1.75 lira suggested by Gov. Erdem Başçı, the picture in front of us could hardly be seen as success.
When a central bank starts burning its reserves this fast, a very simple question comes to mind: do we have enough ammo? According to policy makers, we, of course, do. According to data released yesterday, the bank – as of Oct. 4 – had gross foreign exchange reserves to the tune of $85 billion.
Policy makers like to contrast the current state of reserves with the situation in 2002, marking the start of the Justice and Development Party’s rule. Indeed, compared with a petty $27 billion, the rise is impressive.
However, we need a degree of relativity to put the data into perspective. In 2002, Turkey’s gross domestic product (GDP) was at $232 billion (in 2010 prices). Forex reserves corresponded to 11.6 percent of GDP. In 2010, we had a GDP of $741 billion, versus forex reserves of $77 billion – 10.4 percent of GDP. If we assume 2011 GDP as 1,215 billion liras and the average currency rate at 1.75, we have a 2011 GDP estimate of $694 billion. Thus, we have a reserve-to-GDP ratio of 12.1 percent.
We can take other measures into consideration: As of 2010, for example, the ratio of forex reserves to short-term external debt stands at 132 percent – down from 143 percent in 2002.
Another comparison could be related to an M2 measurement, which represents the amount of money in circulation. As of 2010, gross foreign exchange reserves stand at 19 percent of M2, way down from 2002’s 41 percent.
A Bank for International Settlements paper provides a regional perspective: In the 12 countries clustered into the Central and Eastern Europe group, the average ratios of foreign exchange reserves to GDP, short-term external debt and M2 stand at 20, 188 and 62 percent, respectively. Contrast that with Turkey’s 11, 132 and 19 percent.
Erkin Işık of BNP Paribas has calculated that if the Central Bank sells $10 billion more, “all FX reserve ratios will decline to or below their critical levels.” In his Oct. 5 analysis, Işık reminds the Central Bank criteria that gross FX reserves (excluding gold) should cover at least three months of imports and 100 percent of short-term debt. According to his calculations, the latter ratio stands at 98 percent as of September, while alarm bells should start ringing about the former if reserves fall below $77 billion.
To conclude, we don’t have a reason to boast about how big our reserves are because apparently they are not.
Another timely piece from Taylan, especially when you think about it came out right after the Central Bank’s huge FX selling auctions (I am publishing it nearly a week late).
Let me illustrate with a picture:
Of course, it is important to note that this intervention was not exogenous; the Bank was responding to the FX liquidity need in the market, as evident from the record-level demands. If you speak Turkish, Ugur Gurses, one of the few Turkish economics columnists I enjoy reading (that’s the closest to outright endorsement you’ll ever get from me), made a similar point in his Radikal column right after the interventions.
And in case you are wondering my thought on these interventions: I don’t think you can fight currency markets in the long run. But in the short run, the Bank will need to ease liquidity. As Mr. Gurses rightly notes in the same column, all the measures enacted the week before, around the time of the interventions, were liquidity-related. And since everyone is doing it, from Hungary all the way to Korea, you might as well join the bandwagon. Finally, the measures could also have a signalling effect: If the Bank can convince markets that it is dead-serious and it has the adequate ammunition, it might scare off markets for a while from testing the lira (and the Bank), as I noted in a phone interview for a piece in my own Daily News.
Of course, the key question is then if the Bank has enough reserves. And I am sorry to say I would have to agree with Taylan that it barely does, at best. Here are a couple of the measures Taylan mentions in the column:
At its latest meeting with bank economists, the Bank mentioned that the current measures of short-term debt are not accurate. First, they are based on original maturity, not days to maturity. Second, they include local banks’ branches abroad. The Bank will start publishing short-term debt that will take into account these factors soon. While the Bank’s points make sense, there is only so much leeway you will get with accounting gimmicks like this; you are at best buying time.
Besides, if you used the IMF’s more sophisticated methodology, which was presented in Istanbul back in April at an ERF seminar, with your friendly neighborhood economist as the discussant, Turkey would probably look even worse in terms of reserve adequacy.
But my big problem with the interventions is not whether the Central Bank has enough reserves or not. I am more worried about the dangers of a Central Bank talking about the desired level of an exchange rate in a floating rate regime. This concern was voiced by ex-Central Bank Governor Durmus Yilmaz as well. Now, if you ask the Central Bank (and someone did in Monday’s ERF Monetary Policy conference- more on that in another post), the Bank will tell you they are not targeting a level of the exchange rate. But then Governor Basci comes out saying, when USDTRY is 1.85-1.90, that the lira is 10-15 percent undervalued. I get my Blackberry out (I have been finding different uses for it since this week’s email outage), multiply 1.85 by 0.9 and I get 1.67. Now you tell me what this is:)
One final issue that needs to be discussed is whether the previous week’s +USD 1bn intervention worked or not. Pro-government papers were saying it brought down USDTRY by 5 kurus (0.05 liras); others were mentioning a 3 kurus figure. To put this into perspective, a graph is in order:
As you can see, the global risk appetite improved quite a bit right after the interventions. So it is kind of difficult to determine what part of the strengthening of the lira should be attributed to global risk appetite and what part to the CBT…
One Response to “Weekly Guest Column: Our (Turkey’s) Mighty FX Reserves”
[...] International reserves provide a certain degree of insurance against capital flow volatility. Among the EMs surveyed, Russia and India stand out for their relatively large caches of international reserves, while Turkey ranks near the bottom of the pack, both as a % of external debt and % of GDP, which is a potential source of vulnerability. Blogger Emre Deliveli, as well as journalist Taylan Bilgic, questioned the adequacy of Turkey’s reserves in a recent column. [...]