Türkiye plans gradual exit from FX-protected lira scheme

Newly elected Vice President Cevdet Yılmaz on Thursday said Türkiye could not immediately abandon a government-backed scheme that safeguards Turkish lira deposits against foreign exchange depreciation, adding the country would follow a gradual exit.

The scheme, unveiled in late 2021 and known by its acronym KKM, sought to keep dollarization at bay by encouraging people to keep their savings in lira through guarantees to compensate for losses from decline against hard currencies.

“We do not have an understanding of ending the KKM immediately,” Yılmaz told a televised interview with private broadcaster CNN Türk. “We will act gradually. We will continue making lira-denominated instruments attractive and taking the necessary measures.”

Yılmaz said that the scheme could be extended beyond the end of this year and that an immediate exit from the scheme would risk a sharp decline in the lira’s exchange rate.

The volume of deposits under the scheme has reached about TL 2.58 trillion ($110 billion), a new peak, according to the Banking Regulation and Supervision Agency (BDDK) data. The volume rose by nearly TL 4.4 billion in the week ending June 9, marking a 22nd straight weekly increase.

The budget payments into the KKM since March 2022 have reached just over TL 97 billion, according to the Treasury and Finance Ministry data.

The lira has lost some 20% so far this year after declining 44% in 2021 and 30% in 2022. The currency stabilized from record lows earlier this week and traded at 23.676 against the U.S. dollar on Friday.

Yılmaz said there is no situation to worry about on the exchange rate front, suggesting that it would be more meaningful to look at the real exchange rate.

“If the exchange rate does not move in an inflationary environment, it means that the lira is gaining value. I don’t think we will see a movement in the real exchange rate,” he said.

Asked where the depreciation could stop, Yılmaz said it does not have a negative effect “provided that it is within certain limits.”

“The important thing is that it doesn’t get out of control. We are following a free exchange rate regime. There are no huge movements; it (the exchange rate) finds its own balance with small movements.”

Yılmaz said the government has no exchange rate forecast. “As we increase our exports, as we make moves generating foreign exchange inflows, the exchange rate will also come into order.”

Yılmaz stated that the central bank has to embrace the main framework of the government.

“The central bank will evaluate price stability in accordance with the general objectives. It will take the necessary steps; we will wait and see,” he noted.

Earlier this week, President Recep Tayyip Erdoğan said newly appointed Treasury and Finance Minister Mehmet Şimşek would take quick steps in coordination with the central bank, signaling that Türkiye would return to interest rate hikes to combat inflation, revamping policies centered around monetary stimulus.

Yet, Erdoğan stressed it was a mistake to suggest he had changed his own stance when it comes to interest rates.

A critic of high borrowing costs, Erdoğan had spent the past two years endorsing a “new economic model” that prioritizes ultra-low interest rates. The model aimed at achieving price stability by slashing borrowing costs, boosting exports and flipping chronic current account deficits to surpluses.

“Mr. President expressed his support to Mr. Şimşek and his team. The ways and means that need to be used are technical issues,” Yılmaz said.

Since winning reelection last month, Erdoğan has appointed Şimşek, who is highly regarded by financial markets, as well as a new central bank governor, Hafize Gaye Erkan, a former senior U.S.-based bank executive, in moves seen as heralding a switch to tighter interest rate policy.

Analysts at leading investment banks now expect Türkiye’s central bank to ramp up rates at its monetary policy committee meeting on June 22. The monetary authority has slashed its benchmark policy rate to 8.5% from 19% in 2021.

A day earlier, Yılmaz said Türkiye would take steps to lower inflation and would follow free market rules as it acts to raise competitiveness and productivity.

He said Ankara would maintain fiscal discipline and would implement a consistent set of policies. “We will take effective and determined steps in the fight against inflation, which we see as the main problem,” Yılmaz said after chairing a key economic coordination board meeting.

Annual inflation eased to below 40% in May, a notable regress after touching a 24-year high of 85.5% last October. In comments this week, Erdoğan said he was determined to lower inflation to single digits.

Yılmaz further stated that they expect improvement in the current account deficit from the second half of the year.

“We have a positive perspective in terms of the current account deficit in the second half of the year. We are seeing a decline. We will also support this with our policies,” he noted.

The current account deficit widened to $5.4 billion in April, lifting the shortfall between January and April to $29.7 billion, according to the central bank data.

Yılmaz said the government’s medium-term economic plan, which would be shared with the public in September, will reshape public policies and practices.