Turkey’s CB begins rolling back costly FX-protected deposits

Turkey’s central bank began rolling back on Sunday a growing and costly scheme that protects lira deposits from FX depreciation, marking another move toward more orthodox policies following a shift toward interest rate hikes.

The central bank said in the early hours on Sunday that it lifted targets applied to banks for certain levels of conversions of foreign-exchange deposits to the lira-protection scheme, known as KKM.

In a reversal, the central bank now wants lenders to set a new goal of transitioning KKM accounts into regular lira accounts, in part by dissuading companies and individuals from renewing the KKM accounts. According to a separate decree in the Official Gazette, the central bank also raised lenders’ reserve requirement ratios for FX deposits, further nudging customers into regular lira accounts.

President Tayyip Erdogan’s government introduced the KKM scheme in late 2021 to arrest a historic plunge in the currency, which had been brought on by his unorthodox drive to slash interest rates despite rising inflation.

KKM accounts have since ballooned to some $117 billion, or 3.1 trillion lira, around a quarter of total bank deposits. This has been stoked by a roughly 68% fall in the lira in the last two years.

To cover KKM depreciation costs, the central bank paid an estimated 300 billion lira ($11 billion) in June and July, when the lira plunged again. This month’s costs were estimated at 350 billion lira.

The lira has been stable over the last month and closed last week at 27.02 to the dollar, an all-time low.

After winning re-election in May, Erdogan named a new finance minister and central bank chief to drive a policy U-turn including 900 basis points in rate hikes, and authorities have also pledged to ditch dozens of previous regulations to cool inflation and balance the trade deficit.

The central bank said the KKM move would “enforce macro financial stability by supporting lira deposits” and pledged more such steps. For FX accounts with up to one-month maturities, the reserve ratio was raised to 29% from 25%, the presidency’s Official Gazette said in a separate overnight announcement. Those up to a year have a 25% ratio.

Hakan Kara, former central bank chief economist who is at Bilkent University, said the bank seeks to “kill two birds with one stone” by raising deposit rates while curbing KKM accounts. “Official interest rates could have been raised without engaging in these complex affairs,” he added.

Separately, Turks will get little reprieve from a soaring cost of living this summer as economists expect prices to jump by as much as 8.5% in August, underlining Ankara’s challenge as it embarks on a painful path toward more orthodox policies. The sustained inflationary pressure, driven by a lira drop and tax hikes, comes as President Tayyip Erdogan’s new finance minister and central bank chief orchestrate a policy U-turn including interest rate hikes that are expected to slow domestic demand.