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Turkish central bank’s reserve buildup impacts lira stability: report

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Turkey’s central bank is shifting strategies to prevent the lira from appreciating too much, a move that involves injecting large amounts of liquidity into the financial system, Bloomberg reported on Friday.

Turkey’s central bank, which previously sold reserves to support the lira, is now buying foreign currency to prevent excessive appreciation. According to Goldman Sachs, these purchases totaled $43 billion in the past four weeks. This strategy has flooded the market with lira, requiring the central bank to implement measures to absorb this excess liquidity.

The managed approach to the lira now resembles the Chinese yuan and the Indonesian rupiah, according to SEB AB. Despite this, the lira has only risen about 0.4 percent against the dollar since a slump before the March local elections, compared to over 2  for currencies like the South African rand.

Speaking to Bloomberg, Goldman Sachs economists Clemens Grafe and Başak Edizgil highlighted the challenge the central bank faces in avoiding a nominal appreciation amid rising foreign inflows and favorable current account conditions.

Turkey’s high domestic interest rates, the highest among G20 nations, are a key factor driving this pressure. These rates are part of efforts to control inflation, which is above 70 percent. Central Bank Governor Fatih Karahan indicated that monetary policy would remain tight until inflation expectations decrease, with rate cuts expected no sooner than the final quarter of the year.

This environment has created an arbitrage opportunity, with investors borrowing where rates are low to invest in Turkey. Bloomberg Economics estimates that inflows related to this carry trade have increased by about $16 billion since the March elections.

Goldman Sachs forecasts continued inflows from abroad as long as high inflation expectations delay interest rate cuts, which would exert considerable upward pressure on the lira. Bloomberg economist Selva Bahar Baziki expects the lira to remain relatively stable in the short term due to favorable interest rate differentials.

The capital inflows are helping the central bank to replenish its reserves, but not all of the excess lira is being withdrawn from the economy. This has led to the introduction of sterilization measures, with the central bank keeping interest rates stable on Thursday.

SEB’s Erik Meyersson warned that a controlled lira could incentivize higher imports, which would create unsustainable economic distortions given the central bank’s limited reserves.

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