USD/TRY breached the 41.0 level this week amid media and policymaker commentary about positive developments on the economic front. The lira exchange rate versus a 50-50 basket of USD and EUR is depreciating at faster than 40% annualised. Just before USD/TRY breached 41.0, policymakers had formally ended the FX-protected deposit scheme (KKM), halting new account openings as of 23 August. Existing balances of about $11bn will mature by year-end, with the heaviest redemption anticipated in October, Commerzbank's FX analyst Tatha Ghose notes.

Underlying inflation momentum is nowhere near target yet

The programme was one of the costliest experiments in Turkey’s economic history, accumulating a fiscal burden of roughly $60bn. Shutting KKM is politically and symbolically significant, because it was a signature ‘soft capital control’ and its end represents a step towards exit from unconventional policies. From a market point of view though, we do not anticipate any positive impact. It does not surprise us that USD/TRY breached an important level right after these announcements. First, the ending of KKM had been promised by policymakers and anticipated by the market. Secondly, the availability of KKM might have boosted the lira in a short-term technical sense. Last but not least, investors are unlikely to specially reward a reform that undoes a recently introduced distortion."

"Meanwhile, risks in the corporate sector could be moving in the opposite direction: we recently received data that the net FX deficit of non-financial corporates widened by 4.7%m/m to $185.8bn in June, hitting the widest deficit since 2018. Turkey’s short-term FX surplus contracted by nearly a third, leaving firms more exposed to swings in the exchange rate. On the surface, external buffers appear healthier. Gross international reserves have rebounded strongly. FX reserves have recovered from their Q1 low, but stand only at around $77bn (they used to be $90bn in January); reserves (net of swaps) stand at $45.2bn. In other words, there has been some rebound since the dip induced by the political volatility of February-March, but the rebound only partly made up for the decline."

"In conclusion, investors may be cheering a couple of months of modest inflation deceleration and other good news. But, challenges lie ahead. Underlying inflation momentum is nowhere near target yet, and some imbalances – for example, the trade deficit – are worsening once again. Against this background, we anticipate the exchange rate to keep depreciating at a fast pace."