The Turkish currency is rising after Erdogan discovered savings in the lira

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The Turkish lira strengthened on the second day of chaotic trading after President Recep Tayyip Erdogan unveiled a new austerity scheme that analysts described as a covert increase in interest rates that could disrupt public finances.

Tuesday’s profit leaves the currency up about 50 percent from a record low in previous trading.

Intense volatility has been fueled by Erdogan’s new plan to lure Turkish savers into dollars and gold by compensating them for exchange rate losses if they keep their money in lira.

The currency recently traded at around 12.6 TL against the US dollar, after reaching a record low of 18.4 TL on Monday before dramatically reversing the exchange rate. Monday’s shifts were the biggest on Refinitiva’s records dating back to the early 1990s.

Refet Gurkaynak, a professor of economics at Ankara University in Ankara, described the new scheme as “actually a strong increase in interest rates”. He said it could bring stability to the currency, but warned that it could also have “dangerous consequences”.

This was reiterated by Wolfango Piccoli, a Turkish analyst at consulting firm Teneo, who said the move was a “covert exchange rate increase” – and that it would be determined solely by the exchange rate.

“This huge increase in exchange rate indexed interest rates means that taxpayers will fund the rich so as not to lose on [foreign exchange] front, ”he wrote in a note to clients, adding that the scheme would put almost all currency risk on the state.

Erdogan, a staunch opponent of high interest rates, has ordered a series of rate cuts in recent months despite double-digit inflation.

Although the Turkish president claimed that his “new economic model” would boost exports, investment and job creation, it put a lot of pressure on the Turkish lira. The currency lost about 50 percent of its value against the dollar in the three months before Erdogan’s announcement.

The exodus of foreign investors from Turkey in recent years means that the pressure on the lira has been largely encouraged by Turkish citizens and businesses.

Reluctant to save money in lira, the value of which was undermined by rising inflation and negative real interest rates, they instead rushed to the dollar and gold. This in turn led to further pressure on the currency.

In a bid to reverse the “dollarization” trend, Erdogan announced late Monday that his government would offer a “new financial alternative to citizens” which he said would allay their concerns about the impact of the lira’s fall on their savings.

The government will compensate savers, he said, for any losses if the fall in the exchange rate exceeds the interest rate offered by banks.

“From now on, there will be no need for any of our citizens to transfer their savings from the lira to a foreign currency because they are worried that the exchange rate could rise,” the Turkish president said.

Turkey’s finance ministry has said the scheme will be open to individuals only, not businesses, and will be required to lock up its money for at least three months to take advantage of the exchange rate guarantee.

Although they did not give details on how the initiative will be financed, analysts expressed concern that the Turkish treasury would bear the risk of compensating savers for all exchange rate losses.

While Turkey’s public finances remain strong compared to many other emerging markets, the foreign exchange component of central government debt reached 60 per cent of total debt in October, up from 39 per cent in 2017. This means that every time the lira slipped in against the dollar, it has become more expensive for the government to service its debt.

Citigroup said that, from the Treasury’s point of view, the new scheme “could prove to be a more expensive alternative to tighter monetary policy in the event that interest rates on lira deposits are below currency depreciation and thus negatively affect fiscal performance.”

“We believe these measures can bring temporary relief as the government seeks to further implement its new economic model program,” said Luis Costa, currency strategist at Citi, adding that the bank was abandoning its recommendation to bet on a further fall in the lira.

However, the program will do little to discourage Turkish savers from seeking non-lira assets as protection against rising prices, he added. “We do not see how this can solve the problems with local currency assets in Turkey that arise from [currency-led] inflation, ”Costa said.

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