By Ebru Tucay, Nevzat Debranoglu

ISTANBUL (Reuters – President Tayyip Erdoan’s plan for defending lira deposits might have helped to pull the Turkish currency out of the brink. However, there are still serious risks associated with piling up debts or inflaming an already rife economy.

Erdogan’s Monday promise was centered on a tax-free, effective guarantee that Turks would receive the difference in interest rate and currency movements between their deposits. This encourages savers and investors to buy lire and sell dollars.

Analysts and bankers are concerned that Erdogan’s Turkish government will be responsible for future losses due to the currency rate.

Erdogan’s pledge is an important step in the right direction. Erdogan had previously staked his economic plan on decreasing rates and rejecting the idea of interest. Turkey’s finances are stronger than those of other emerging market nations, so it has room for support.

Erdogan announced his decision just hours before the lira broke 18 to $1 on Monday. Erdogan outlined a number of measures that would reverse an influx of deposits from lira into dollars.

According to official data, term lira deposits were held by ordinary Turks at around 1.2 trillion lire ($92.5 million) as of Dec. 10.

The new measures would not cover the entire cost of inflation. If Turkey’s central banking deposit rate increases 20% faster than the exchange rate, Ankara will suffer a budget hit of approximately 240 Billion Lira, Hursit Gunes (an economist at Marmara University) estimated.

Although questions like when and how the Treasury will pay the relief and what to do about it remain, the new policy provided much-needed protection against erosion for depositors.

Reuters received a report from bankers stating that they had converted more than $1.5 Billion in savings to Monday night. This drove volatile trading’s largest ever rally for the lira. [USN LINK]

Refet Gurkaynak from Bilkent University’s Ankara economics department stated that “if you anticipate the exchange rate increasing by two percent, as it did (in the past two months), then the return of lira deposit is 100%.”

He added, “But it could have deadly consequences.”

Turkish banks offer deposits rates of 16-18%, and it is unlikely that they will pay more. The policy interest rate for Turkey has been 14% since an unconventional and aggressive monetary ease cycle.

Erdogan has pressed Turkey’s central banking to cut its rates by 500 basis point since September. This triggers the worst liquidity crisis in two decades, triggering fears of an inflationary spiral.

“NO FREE LUNCH”

The currency crash that stokes import prices has pushed annual inflation to 21%. It was above 30% last month. Erdogan’s rating is being hit by higher inflation in food and other essential goods.

A pollster stated that Erdogan could be planning to hold elections within the next month, in order to avoid mid-2023 elections.

I expect a snap vote. MetroPoll President Ozer Sencar stated that what has been accomplished in the economy is an election strategy.

A further currency decline could lead to unlimited amounts of Treasury debt. Bankers and analysts suggested that the Treasury could now turn to its central bank for monetization, creating an inflationary wave.

There is no “free lunch” for the lira. “Corporations will ultimately pay the cost of these support measures in the form either higher borrowing costs, or higher taxes,” said Hasnain Maklik, Tellimer’s head of equity research.

He said, “There’s no way to escape the need for reestablishing an acceptable interest rate policy environment.”

Although a source familiar with the issue acknowledged inflation and a rising budget, the government sources said they could manage them. They also added that all the announced decisions include safeguards against risk.

Cemil Ertem is a Presidential Advisor and member of Government’s Economic Policies Committee. He told Reuters that the deposit guarantee represented a “historical change” which removes the need for individuals to have dollars in order to guard against inflation.

However, a top banker stated that the new policy would only be effective if there is a surplus in the current account. The Treasury did not provide any details on Tuesday but the government needs to clarify some points.

Turkey’s deficit budget is forecast to increase by 3.5% from the 1.5% it had earlier this year.

What is the Treasury’s plan to pay the difference and how often? Are they going to pay it once every three or six months? According to the banker who requested anonymity,

($1 = 12.9741 liras)