FRANKFURT: A central bank that staked its reputation on a stable currency has some tough advice for Turkey: Be bold to stem the lira crisis.
“I’m convinced this downward spiral can be stopped,” said Joachim Wuermeling, an executive board member at Germany’s Bundesbank, which spent decades defending the Deutsche mark before the introduction of the euro. “There are classic instruments Turkey can use. But bold action is missing,” said Wuermeling, who helps supervise the region’s largest banks.
Turkey is in turmoil as a face-off with the US compounds issues built up by years of growth-at-all-costs policies. Turkish President Recep Tayyip Erdogan, has vowed the country won’t use higher interest rates to bolster the currency and choke consumer-price growth. The lira has lost about a quarter of its value against the dollar since the US sanctioned two government ministers, pushing the economy toward a full-blown financial meltdown.
Wuermeling said there’s no need to “over-dramatize” the risk that Turkey’s problems will infect the euro area. The Bloomberg Europe Banks and Financial Services Index fell 2.7% in the week through Monday, led by lenders with direct exposure to the country through their units there. Stocks rallied Tuesday. Wuermeling said supervisors have the option to order banks to hold more capital against Turkey assets.
“A worsening of the situation in Turkey would put pressure on profit at the banks,” analysts at Frankfurt-based DZ Bank AG wrote in an emailed report on Monday. “But the diversification of their businesses means that strain looks manageable.”
Investors should still take “defensive” positions on European bank bonds given the “tense” market environment and fallout from political risks, they said.
While Turkey’s central bank raised borrowing costs to 17.75% in June from 8% in April, it hasn’t tightened since. In a July 24 policy decision, the first since Erdogan won re-election along with sweeping new powers, officials bowed to political pressure to refrain from raising rates again. Erdogan holds some unorthodox economic views, notably that cheaper credit leads to slower inflation.
“A country that relies on foreign creditors for half of its financing needs can’t lastingly ignore the rules of global financial markets without suffering damage,” Wuermeling said in an interview in Frankfurt Monday. “Turkey shows the bad that can happen if central bank independence is ignored.”
The lira rallied on Tuesday and was up 5.7% as of 9:54 am in Istanbul. The currency has dropped more than 40% this year, making it the second worst global currency after Venezuela’s bolivar. The depreciation has stoked an inflation rate that breached 15% last month, more than triple the official target.
The Bloomberg banks index was up 0.5% as of 9:32 am in Rome. Lenders with high exposure to Turkey such as Italy’s UniCredit SpA and Spain’s Banco Bilbao Vizcaya Argentaria were among the biggest gainers.
The European Central Bank has the option of crisis-proofing lenders by ordering them to increase reserves for risks, he said. Wuermeling, who is a member of the ECB’s supervisory board, said it hasn’t yet seen the need to call an emergency meeting on Turkey.
Click here for an overview of the European banks with the highest exposure to Turkey.
In times of turmoil, supervisors generally ask banks about their liquidity, their exposure to troubled markets and what collateral they hold. The Bundesbank doesn’t see a need to make “supervisory demands,” according to Wuermeling. While the country’s banks, which have 20.8 billion euros (US$23.7 billion) of risk tied to Turkey, none of the major European lenders with extensive operations in Turkey are German.
On the monetary policy front, the Bundesbanker said he doesn’t see any reason to put in place currency swap lines to maintain Turkey’s access to euros.
“It’s up to Turkish authorities to engage in confidence-fostering measures to ensure creditors don’t withdraw their money,” he said.