Turkey Restarts FX Swaps to Counter War Impact on Reserves

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(Bloomberg) — Turkey restarted foreign-currency swap transactions with local banks for the first time in a year, after a drawdown in reserves fueled by a broad selloff across emerging markets amid the war in the Middle East.

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The Turkish central bank on Tuesday opened three separate dollar-for-lira swap auctions totaling $10 billion, with maturities ranging from one week to one month, under which it will borrow dollars from lenders in exchange for liras.

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Governor Fatih Karahan said the resumption of swap deals shows “there’s no issue with regards to FX liquidity in the system and that the exchange rate regime we’re pursuing is functioning in a healthy manner,” according to state-run Anadolu news agency.

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The announcement came after the monetary authority drained around 2 trillion liras ($45 billion) from the interbank market in March, a step aimed at maintaining a tight monetary stance. The US and Israel started a war on Iran on Feb. 28, triggering outflows from riskier assets and declines in nearly all emerging-market currencies tracked by Bloomberg. 

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The lira has emerged relatively unscathed, dropping 1.2% since the war began, compared with declines of 6.8% in South Africa’s rand and 6.5% in Chile’s peso.

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But scarce lira liquidity drew banks’ ire, with some executives calling for a resumption of currency swap transactions to ease the squeeze. 

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Earlier in March, the central bank tightened monetary conditions by providing funding via its costlier overnight lending rate of 40% instead of lending via one-week repo auctions at its policy rate of 37%. 

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FX swaps with local lenders were criticized in the past for providing a temporary boost to foreign reserves without actual foreign inflows. Turkey’s gross foreign exchange reserves fell by more than $12 billion during the three-week period through March 20, according to the most recent official data compiled by Bloomberg.

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Since the start of the war, the Turkish central bank has spent more than $30 billion from its reserves, including through gold sales or swaps, to shield the lira from conflict-driven turbulence seen across emerging markets.

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Turkey’s monetary strategy relies on maintaining a stable lira when adjusted for inflation, with state-run banks intervening in the foreign exchange market when needed. 

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Higher energy import costs and increased dollar demand amid the ongoing conflict in the Middle East could make that strategy more challenging to sustain.

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“We are faced with an external situation that’s affecting our inflation fight negatively. We are determined to maintain the necessary tightness for the continuation of disinflation,” Karahan said Tuesday.

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On Monday, central bank Deputy Governor Cevdet Akcay warned of the uncertainty emanating from the war and the potential risks to Turkey’s economy.

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“The proactive measures we took were very appropriate. We are now looking on a daily basis whether the ones we’ve taken later are enough,” he told reporters in Istanbul. “Restarting swaps alone doesn’t mean much but it could be a very appropriate measure with different combinations,” he added. “We are looking at everything. We’re looking at it day and night.”

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—With assistance from Tugce Ozsoy.

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