Turkey on Curbing Dollar Derivatives to Boost Lira

Turkey’s Central Bank is examining a plan prohibiting banks from selling currency derivatives to consumers. This is the latest attempt to limit the rise in dollar demand and give space to the lira among businesses.

Monetary authorities developed a new rule that would compel banks to keep forward contracts collateral. According to individuals familiar with the talks, the objective is to reduce demand for hard currency in the spot market eventually. The people said it’s still being hammered out, and the specifics haven’t been finalized. Because the arrangements aren’t yet public, they requested that their names not be published.

For authorities, maintaining the lira is critical to their effort to control inflation, which was over 85% late last year. After losing over 30% of its value in 2022, the Turkish currency is down less than 1% versus the dollar this year. After Argentina’s peso, this was the worst performance in emerging markets.

What Are Some of The Implications of The Regulation?

Collateral requirements might discourage lenders from providing forwards to their customers, which would be detrimental. As a result, they encouraged investors to hedge their bets on regulated futures markets, such as VIOP, where their options are more restricted. Forward contracts are agreements to buy or sell an item at a set price on a future date.

Authorities said that the proposal is intended to reduce demand for dollars in the open market. A bank buys the same amount of hard currency to hedge its exposure when it sells a forward contract to its customers. VIOP transactions don’t require this procedure.

To protect against risks to the lira, which is currently close to record lows, companies have become reliant on customized contracts with banks that offer hedging tools more tailored to their needs.

The lira is one of the few currencies that still offer negative real yields. Due to a carefully orchestrated approach that includes interventions, it has stayed within a tiny range since September.

Throughout August and November of last year, policymakers cut interest rates by 500 basis points and below. By eliminating a buffer against market selloffs, they exacerbated inflation and made the lira more vulnerable.