Turkey Intensifies Currency Intervention

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Win Thin

NEW YORK ( BBH FX Strategy) -- Turkey's central bank sold $750 million and bought Turkish lira in its daily auction Wednesday. It offered as much as $1.35 billion and received $1.83 billion in bids.

On Tuesday the bank offered and sold $140 million and received $375 million in bids. On Monday, it offered and sold $50 million and received $140 million in bids.

This clearly shows the intensification of forex activity. The central bank said that large dollar auctions may continue. The intensified intervention this week came as the dollar/Turkish lira currency pair (USD-TRY) made new highs for the cycle at more than 1.90.

In the current environment, however, the most that the Turkish central bank should do is to provide two-way liquidity in the forex market and not to defend any particular level.

We remain skeptical about this current bounce in sentiment and risk appetite, and we continue to believe that emerging markets remain vulnerable to further bouts of selling.

In this environment, we think emerging-market currencies with weak fundamentals will continue to underperform.

With EM reserve data being released now for September, we remind our readers that the drops reflect both forex intervention activity and valuation effects.

That is, with the dollar significantly stronger across the board last month, reserves held in euros and other currencies were worth less in dollar terms. For instance, foreign reserves held in Australian dollars would have seen a 10% valuation loss in September.

Turkey's foreign reserves stood at only $85.65 billion at the end of September, which we see as very limited firepower. Reserves have fallen about $7.4 billion (down 8%) from the July peak.

According to the latest triennial survey by the Bank for International Settlements, the average daily turnover of the TRY was $14 billion in 2010.

Burning through almost $1 billion per day is simply not a sustainable strategy. In a bit of a backdoor move, the central bank seemed to acknowledge this shortfall by doubling the amount of reserves that commercial banks are allowed to keep in foreign currency. It said that this move could boost central bank reserves by as much as $3.6 billion.

Source: Bloomberg

We note that Turkey has moved into very worrisome territory. According the central bank, short-term external debt rose to $84.96 billion, or basically 100% of foreign reserves this year.

This is a very important ratio, and shows how vulnerable a country is to short-term swings in sentiment that can lead to capital outflows and forex volatility. Most in Asia and Latin America have much lower ratios, as Korea and Indonesia are both around 45%, Malaysia, Taiwan, and Thailand are all around 20%, and Brazil is at 20%.

Countries in Europe, the Middle East and Africa typically do not have big war chests of reserves, and so their ratios are typically very high. Besides Turkey at 100%, Hungary is almost 120%, Bulgaria is around 105%, and both Czech and Poland are around 75%. South Africa is relatively low, at around 50%.

Markets have been punishing countries with the weakest fundamentals, focusing on either high inflation, large current account and budget deficits, external debt loads, or a combination of these.

These other vulnerability measures in the table also support the widely held view that Asia has the strongest fundamentals, EMEA the weakest, and Latin America somewhere in between. But we do note that there are pockets of vulnerability in Asia (India, Sri Lanka, Vietnam) and Latin America (Argentina).

Sources: Bloomberg, IMF, BBH

In related news, it appears that the Russian central bank intervened directly in the forex market yesterday to the tune of $1.15 billion, according to Chairman Sergei Ignatiev.

During the last protracted ruble (RUB) selloff in 2008-2009, Russia burned through its reserves quite significantly, falling from a $596 billion peak in July 2008 to a trough of $384 billion in March 2009, a drop of $212.7 billion, or 36%.

Reserves were rebuilt to a peak of $545 billion in August and dropped $19 billion to $526 billion as of Sept. 23. Private capital outflows continue. They were reported at $18.7 billion in the third quarter and are expected to continue in the fourth. However, we note that the short-term debt-to-reserves ratio for Russia is a low 23%.

Source: Bloomberg
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.