Midnight Express

Of course I am not here to talk about the Academy Award winning movie although it has some detail that many Turks find ugly. Our monetary policy markets decided to hold an extraordinary meeting yesterday and it has seemed to have the desired effect so far. There has not been no intervention by selling already not sufficient foreign exchange reserves. Like many others, I thought that it was the political pressure by government on Turkish Central Bank not to raise the rates, although it should have done already, and no wonder because of the interest rates lobby, which is a group of people is believed to exist, to squeeze the country financially, and to prevent the government from building bridges, airports, canals, roads and to have secret connections with Gezi Park protesters, the opposition party, some Turkish businessmen, Israel, the US, the UK, London-based financial institutions, Vatican, Templars, and so on…


The extraordinary meeting will be start this evening, and we will be informed about the decision at the midnight, and that is why I am calling the meeting “Midnight Express”. Turkish Central Bank only decided to hold this kind of meeting when it about raise the rates shockingly. And yesterday, just after announcement, the expectations for the surprising hike led Turkish Lira soar and Lira has rallied over 1200 bps since then.

Here is some notes from the economists’ reports. It is expected that Turkey needs to raise overnight rates by 300 basis points for market effect, however, it could be even higher, because it is strongly doubtful for Turkish Central Bank to regain the investor confidence. Beside of “a meaningful hike“, a more simplified monetary policy must be adopted which I find crucially important in central banking unlike Turkey’s policy makers. We have a marginal funding rate of 7.75% while policy rate is at 4.5&, but somehow Central Bank decided to engineer interbank rates at 9%.

and here is some notes from an earlier post:

Simply, the CBT is running the strangest monetary policy in history but luckily it is trying to gain some understandability now. With the recent trend line on both inflation and FX rates, we will see much more normalization, just because the CBT has no room for avant-garde policy implications.

Finally, I remain 100% confident that CBT most lately will hike the rates at the mid of 2014.

Frankly speaking, another strange action to be taken by CBT is what I am afraid most of. Today, on a meeting with economists and journalists, Erdem Basci, the Governor talked about a possibility of serious slowing in economy despite he articulates a hike in interest rates. Maybe, we will only see a hike in top line of the interest rate corridor towards 12% but not policy rate, that would definitely not simplify the monetary policy.

Lira is traded at 2.26, and 2-year bond rates are over 11% at the moment. See you at midnight.

Does Turkey Have Sufficient Foreign Exchange Reserves ?

What sort of crisis is now confronting the emerging world? The question commonly has been a matter of debate for a while. One thing most economists seem to agree on is that this is not a replay of the late 1990s. There are no exchange-rate pegs and large debts denominated in foreign currencies to be threatened by capital outflows anymore. However, following the capital rushing to the developing world,  private firms started to have quite a lot of debt denominated in foreign currencies (I recently compared Turkey and South Korea and argue that how things are getting ugly in Turkish banks within the frame of external indebtedness). At this stage, the problem is turning into something that economies with high levels of international reserves are better able to withstand the effects of.

Global Trends

It is necessary to touch upon the global trends in foreign exchange reserves. From the beginning of 2000 to the beginning of 2008 global foreign exchange reserves rose from just under $2 trillion to more than $7 trillion. The emerging world accounted for most of the rise; its reserve holdings soared from less than $1 trillion to $4.7 trillion. Turkey was in deep crisis through 2000 and 2001,  and forced to use foreign change reserves to stabilize its economy. Its reserves hit the lowest level at $15.9 billion in July 2001, then reached at $76.8 billion in October 2008. That means that the increase of Turkey’s reserves were on par with the emerging world.

FX Reserves and Short-Term External Debt

The relationship between foreign exchange reserves and short-term external debt is hot topic for many economists. Guidotti-Greenspan rule is being widely used to determine that whether a country has enough reserves to resist a massive withdrawal of short term foreign capital. It is simply stating that a country’s reserves should equal short-term external debt. In addition, according to Calafell and Del bosque the ratio of reserves to external debt is a relevant predictor of an external crisis (see their work here).

The chart below shows how Turkey has performed so far.

Turkey - FX Reserves - Short-Term External Debt - Guidotti-Greenspan Rule

Obviously, Turkey has been much closer to a major crisis arising out of it short-term external debt than it had been until the end of 2011. I used a 12-month average of the ratio to get the data clear which is only another way to tell the same horror story. Franky speaking, Turkey does not have enough reserves to face a possible challenge of capital outflows. Particularly, it is the banking industry entangled with debt trap, and likely to hurt most.

Research by economists Philip Lane and Jay Shambaugh concludes that reserve growth is the single biggest source of improvement in emerging-market exposure to foreign currencies. Another paper by Matthieu Bussière, Gong Cheng, Menzie Chinn, and Noëmie Lisack examines emerging-market performance during the crisis of 2008. They find that the ratio of reserves to short-term debt strongly predicted GDP growth during the global downturn.

Turkey - FX Reserves - Short-Term External Debt - GDP Growth

As evidence shows the relationship between the ratio and GDP growth during the global crisis, Turkey’s economic performance is affirming the theory. Turkey’s quietly large reserves helped it to neutralize the effects of global turmoil and to recover fast.

Using Reserves to Stabilize Currency

Central banks use foreign currency reserves to keep their own currency from devaluing, just like the Central Bank of Turkey has done until the very last moment. Here is another chart telling the dramatic story of CBT’s reserve usage to stop Lira’s depreciating and how markets erase these interventions just in time.

Turkey - FX Reserves -Lira vs Dollar


Turkey is a country with one of the highest stock of short-term external debt ever recorded and insufficient foreign exchange reserves. What is more, Turkey is using its reserves to prevent lira from depreciating in which it has not become inarguably successful. Then, the economy is more fragile… Well, negative synergy could the best term to use here.