The heavy weight of debts denominated in foreign currency. Borrowing in dollars & euros is cheap until it isn’t.
In recent months, Turks have been buying up gold — their traditional safe haven asset of choice — in even bigger quantities than usual. The average daily volume sold at Istanbul’s Grand Bazaar, one of the world’s oldest still-operating markets, surged tenfold between the start of the lockdown, in March, and the end of the lockdown, in June, according to traders cited by the Wall Street Journal. Turkey’s domestic gold production was not nearly enough to meet demand, so $15 billion of gold had to be imported from January to August, up 153% from a year earlier.
They can hardly be blamed for wanting to buy gold, the best-performing currency against the lira over the past ten years, given how quickly the currency in their pockets and in their bank accounts has been depreciating. Ten years ago, it took one and a half lira to buy a dollar. Today, it takes seven and a half. In one decade, the currency has lost 82% of its value against both the dollar and the euro, and 90% of its value against gold.
On Thursday, the lira fell to a fresh low of 7.55 against the dollar, of 8.91 against the euro, having shed 21% of its value against the greenback so far this year and 26% against the euro.
The cost of insuring Turkish sovereign debt has almost doubled. The latest rout follows a decision by Moody’s to downgrade Turkey’s sovereign debt by one notch to B2, five levels below investment grade. It also maintained its negative credit outlook for the economy, citing concerns about Turkey’s rapidly vanishing currency reserves, which “have been drifting downward for years on both a gross and a net basis but are now at a multi-decade low as a percentage of GDP because of the central bank’s unsuccessful attempts to defend the lira since the beginning of 2020.”
Turkey’s central bank has burnt through over 40% of its foreign-exchange reserves trying, clearly unsuccessfully, to prop up the lira, leaving the reserves (excluding gold) at $44.9 billion (as of 4 September). This, as Moody’s says is an “exceptionally low buffer when measured against upcoming external debt payments.”
Turkey’s central bank has been borrowing vast sums of foreign currencies from domestic banks and then selling those currencies to buy lira. These currency swaps ratcheted up the central bank’s net short position in the swap market, from $30 billion in March to $53 billion at the end of July. If they were not rolled over, all the commercial banks’ reserves at the central bank would be insufficient to cover the short position.
Turkey does hold substantial gold reserves. Like it its citizens, it has bought up large amounts of gold in recent months. Due to this increase in gold purchases as well as the recent increase in the gold price, Turkey’s gold holdings are now broadly equal to FX reserves ($42.7 billion at the beginning of September). But it’s still not much of a buffer.
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