Deserves More Reserves…

The Central Bank of Turkey decided to increase the maximum daily amount to be purchased in F/X auctions in order to accelerate the foreign exchange reserve accumulation, citing that capital flows to Turkey have recently grown more stable on the back of the latest developments in global financial markets, as was the case in other emerging market economies. This was not much surprise, considering that the Bank had already been signaling for such moves. In fact, the strengthening tendency of the short term capital flows, which indicates at deterioration in quality of current account deficit financing, has been observed through the balance of payments statistics since the beginning of this year. In January-May period, foreign investors’ portfolio inflow reached a cumulative US$11.6bn, with half of that amount being the purchases in the bond and equity market, while the increase in the deposits, which we believe to be linked with the swap transactions, made the other half. A more recent data posted by the Central Bank in the weekly publication of Non-residents' Holdings of Securities’ indicate at US$7bn year-to-date foreign purchases in the bond market and US$1.3bn in the equity market as of end-July. Note that some US$2.6bn of the total purchases were realized in the last 7 weeks. No doubt, these types of capital flows are exposed to abrupt changes in risk appetite. Yet, these flows have been continuing for quite some time and there are signs that they may get stronger, both of which paved the way for the CBRT to step for raising the F/X purchase size. On the other hand, the CBRT could have well taken this decision by Q2, but the decline in the F/X-liquidity of the banks discouraged the Bank. The steep contraction of residents’ foreign currency deposits in April-June period had dismal impact on the claims from banks abroad. Back then, the interest rate on foreign currency deposits scaled up, while the TRY swap rates came down visibly linked to the increase in banks’ demand for cross-currency swaps. This outlook has been reversed since mid-June and the F/X liquidity rose even above the level in April. Therefore, the Bank was able to raise the foreign currency reserve requirements and the F/X purchase auction size, one after another, both of which would suppress the F/X liquidity.

The Central Bank shows reserve accumulation as the reason behind the increase in F/X purchase auction size. In essence, reserve accumulation is the Bank’s strategic decision valid since liquidity amplified from 2002 onwards. A lot of Central Banks, in particular in Asia, followed this strategy, consequently boosting purchases of U.S. Treasuries and hence letting the U.S. economy to sustain a large current account deficit for very long time. The national reserves surged to US$75.6bn as of end-June from US$21.6bn in the beginning of 2002. However, in percent of GDP, these nominal values translate into a slight increase to 10.5% from 9.3%. This reserve ratio puts Turkey at a rank of 20 in the World, lower than the country’s GDP ranking at 17. The IMF data base, known as COFER, for the total reserve positions in the World show that the total reserves stand at US$8.3trn as of the end-Q1, with 61.5% being US$-denominated and the 27.2% being EUR-denominated. The highest-reserve countries are China (US$2.5trn), Japan (US$1.0trn) and Russia (US$0.5trn), while Brazil has the 8th biggest reserve position with some US$257bn (16% of GDP).

Looking at Turkey’s current reserve position through different ratios, for example reserves to GDP or as a more meaningful measure reserves to external liabilities, underscores the need for accumulating more reserves, especially considering that some US$11bn of the gross reserves are the deposits of the Turkish workers residing abroad. In the literature, the acceptable levels of reserves are described to be the 4-6 months of imports or principal and interest repayments of foreign currency-denominated domestic and external debt maturing in one year. Turkey’s reserve position more than satisfies these thresholds. Nevertheless, the reserves to short term external debt and imports are far from their peaks in 2000-2010 period. The reserves to imports is a measure of how long a country can sustain the inputs needed from abroad without relying on any external financing. The reserves to short term debt, on the other hand, shows what part of the foreign currency debt can be redeemed in the absence of external borrowing. The higher these ratios, the lower the risk premium of these countries, especially the ones with high external debt and hence the less costly would be their external borrowing.

Meanwhile, further details regarding the current structure of the Central Bank reserves are available in the monthly data of International Reserves / Foreign Currency Liquidity The expected foreign currency outflows within a year, as provided in this publication, also underscore the need for reserve accumulation. The Central Bank reports some US$21.7bn of predetermined short-term drains on foreign currency loans, securities and deposits. Even though an important part of this amount would be rolled over, this loaded outflow schedule indicates at the need for regular F/X purchase auctions just to maintain the current reserve level.

In conclusion, the strengthening of capital inflows that played a key role in the external financing this year, as well as the improvement of the F/X liquidity of banks towards normal levels, paved the way for the Central bank to increase F/X purchases in order to accelerate reserve accumulation. When considered together with the recent increase in foreign currency required reserve ratio, the Bank’s attempts address the F/X liquidity and they seem to be in line with the policy of not intervening to the foreign exchange rate level. The Central Bank reserves displayed a rapid increase after 2001 crisis and almost quadrupled since then. However, comparisons based on different criteria and the predetermined F/X outflows underscore the need for maintaining the strategic decision to accumulate reserves going forward.