Turkey’s unorthodox attempts to stabilise the lira by linking earnings from local deposits to the dollar may provide short-term relief but carry considerable risk, said Mohamed El-Erian, chief economic adviser to Allianz and former CEO of PIMCO, which manages $2.2 trillion of assets.
The advantages of the mechanism include avoiding the impact of a partial and implicit interest rate hike on the rest of the economy, encouraging the lengthening of the average duration of deposits – the scheme includes only lira deposits of 3-12 month maturity – and help alleviate mounting inflationary pressures, El-Erian said in the Financial Times on Tuesday.
“These advantages come with considerable risks,” he said. “The mechanism exposes the fiscal accounts/central bank to a large financing burden unless other measures are taken to control inflation and limit renewed pressures on the currency away from dollarisation.
“If the mechanism fails, it will further undermine the credibility of policymakers, making it harder for the next set of measures to take hold quickly even if they are comprehensive and appropriate,” El-Erian said.
Turkish lira deposit holders will determine the outcome within weeks, he said.
“If they trust the policy response and worry little about the potential collateral damage, they will encourage others to buy the domestic currency, domestic and external,” El-Erian said. “The government can help this process by credibly signalling that the latest measures are not an end in themselves but rather a bridge to a more comprehensive set of policies.
“This would include explicit rate hikes by the central bank which, at this point, are still necessary but no longer sufficient. Turkey will also need to seek other internal anchors, such as a tightening of fiscal policy, and perhaps also external ones, such as agreement on an IMF programme that provides both funding and external validations,” he said.
Turkey will need to achieve these steps while “avoiding the temptation of capital controls that would undermine a historically powerful, and still impactful open growth model that, both economically and financially, exploits Turkey’s many “competitive edges”, El-Erian said.
“Through a new set of unorthodox measures, Turkey has bought itself artificial stability. This is unlikely to translate into genuine stability unless Turkish citizens are convinced that their currency crisis has truly passed. This only happens if the government quickly shifts to a more comprehensive – and, yes, more orthodox – policy approach,” he said.
“Failing to do this would further erode the country’s strong economic attributes. After all, there are limits to continuously defying the laws of both economics and finance.”