Increased gold reserves help stabilize Turkey's currency ahead of May elections  

Al-Monitor Pro Members

Piero Cingari

Financial analyst

March 22, 2023

In January, the Central Bank of Turkey (CBT) added 23 tonnes of gold to its official reserve holdings, maintaining the positive trend of the past year. The value of the CBT's gold reserves reached an all-time high of $50.6 billion and account for almost 40% of the CBT's gross foreign assets.

The CBT's new reserve management approach has coincided with a period of relative stability for the lira, but it has not been a driving force behind that. The "liraization" policy implemented by the government last summer led to a greater proportion of lira-denominated deposits and a reduction in exchange rate pressures. This year's general elections in Turkey will certainly be the most influential factor in determining the trend of the Turkish lira.

Scenario 1: Lira's stability continues as the status quo is preserved

In the run-up to the elections, the Turkish government intends to maintain the lira's stability while continuing measures to "de-dollarize" the financial sector.

Under the FX-protection system for lira deposits, the Treasury or the CBT compensates depositors for losses incurred if the lira falls more than the level of interest rate on these accounts. This effectively provides depositors with a free option to preserve the FX value of their deposits. 

Since this system is projected to remain in place until at least for the first half of 2023, lira volatility may be prevented from rising significantly ahead of the elections.

The USD/TRY exchange rate is expected to climb marginally and in a managed way, following the pattern of the last six months and potentially reaching the 19.2-19.4 trading range before the elections.

In the event of no political change, liraization measures will be kept in place for longer, potentially extending the era of relative stability for the lira.

In terms of the CBT's foreign exchange reserves, the liraization measures limit financial account outflows, while reduced energy import costs and increased tourist inflows as the peak season approaches may enhance the current account position, hence improving reserves. A protracted period of relative stability for the lira does not necessitate the CBT selling its gold holdings, as it did in the past during times of high volatility, and hence we may expect the CBT gold reserve to rise in relative terms.

Scenario 2: Opposition is likely to win, and investors begin to price in traditional policies

We can anticipate volatility to return to the Turkish lira if polling data starts to suggest a less favorable outcome for Erdogan or if the opposition really prevails in the elections.

A change in political leadership is likely to necessitate a rethinking of the liraization strategy, with the new authorities opting for more traditional macroeconomic policies.

The opposition, in fact, argues for a return to orthodox monetary policy with an inflation-targeting framework, but abruptly transitioning from one regime to the other might destabilize markets, particularly FX-protected deposits.

As the government aims to phase off the FX-protection scheme, investors may begin pricing a more appropriate exchange rate, and the lira may face more volatility as it seeks a new equilibrium.

The USD/TRY exchange rate might potentially rise to at least 22 TRY to the dollar, implying a 15% depreciation.

Piero Cingari is a financial analyst and writer who has worked as a fixed-income, FX and commodities analyst in the asset management and brokerage industry. Throughout his career, he has covered and analyzed economic and financial developments in Turkey, Egypt, and the Gulf countries. Piero is particularly interested in how major macroeconomic trends influence financial markets and how global geopolitical events may affect the economy of the MENA region.