Erdogan's shock moves revive Turkey's ailing lira

ISTANBUL — Turkey's lira strengthened on Tuesday, after a wild start to the week saw its value swing by 30 percentage points, in response to President Recep Tayyip Erdogan's emergency economic support measures.

The Turkish leader stunned markets and his political opponents on Monday by effectively tying the value of some lira bank deposits to the dollar.

Economists and many Turks were still trying to understand how this new exchange mechanism will work or where the government will get the money to pay for it.

But the impact on the lira — which had lost 45 per cent against the greenback from November 1 to late Monday afternoon — was monumental.

It was trading down 10 per cent on the day by the time Erdogan appeared on national television to announce his new economic proposals after a weekly cabinet meeting.

It was trading up 20 per cent on the day a few hours after Erdogan had finished.

"We finally understood that the Erdogan administration cares about the exchange rate and has avoided capital controls," Economist Timothy Ash of BlueBay Asset Management said in a note to clients.

"Erdogan affirmed that he believes in markets, albeit not interest rates."

Indirect rate hike 

Erdogan holds the unconventional belief that high interest rates cause inflation, rather than tamping it down by slowing economic activity.

He has pushed the central bank to slash its policy rate, so far below the annual rate of price increases — now at 21 per cent and rapidly climbing.

This meant that Turks who put liras in their bank accounts were effectively losing money each month.

Economists feared that Turkey could see a potentially paralysing run on the banks unless something was done quickly.

Erdogan's new policy — dubbed an "indirect interest rate hike" by former treasury adviser Mahfi Egilmez — is meant to defend the value of lira holdings against fluctuations in the exchange rate.

It guarantees that the government will cover any depreciation of lira bank deposits against the dollar through periodic payments.

"If the exchange rate increases by 40 per cent and the interest rate increases by 14 per cent, 26 percentage points will be paid in compensation," Egilmez explained on Twitter.

The policy is designed to manage inflation expectations and make Turks feel safer about their lira assets.

The lira gained a further 22 per cent early Tuesday. It then erased all those gains before climbing back up six per cent by Tuesday afternoon.

Yet, many economists question whether Erdogan's new approach is sustainable.

"The deposit guarantee method will increase the public burden," former Turkish economy minister Ali Babacan told reporters.

"The treasury will pay for it with taxes. This is the dollarisation of the country's economy."

Economists also expressed doubts about whether the move could truly protect Turks from rapid cost of living increases.

"This is still bad policy," Ash said.

"This scheme likely has bought time and avoided an immediate crash in the banking sector but it has done nothing to fight inflation."