Hot money flees Turkey's lira but no wider rout

Seven weeks since starting its offensive against inflows of hot money, Turkey's central bank looks to be winning the battle. Interest rate cuts have sent foreign buyers into retreat, weakening the lira by some 6 percent since the bank launched its bold new policies. Finance Minister Mehmet Simsek stated calmly this week that $8 billion worth of short-term money has left.
Data on foreign flows explains the relative sense of calm. The central bank has managed to engineer, as intended, the weakening of what it viewed as an over-valued currency without sparking a large-scale flight of foreign capital from bonds and shares as it aims to nudge investors into longer maturity investments.
Doubts over progress made by the bank on other fronts however - its fight against rampant credit growth and a surging current account deficit - could curb growth potential for Turkish assets in the short term. The chief fear is that the central bank is inviting higher inflation with its unorthodox mix of interest rate cuts with increases to banks' required reserve ratios, and that it will be forced into a sudden reversal later this year.
Few foreign investors are seen significantly selling out of a country which boasts a young, growing and increasingly wealthy population and where economic growth is forecast at 4-5 percent this year, after probably topping 7 percent in 2010.
"Turkey remains one of our biggest overweights," said George Hoguet, senior portfolio manager at State Street. Data on foreign holdings of short-term lira deposits is not available, but data on treasuries and equities suggests Turkey can still attract the longer-term money it wants.
From mid December until January 28 there has been an inflow of $2.088 billion worth of foreign capital into Turkish treasuries, although $1.1 billion worth of outside capital has left the equity market, whose free float is two-thirds foreign owned.
As recently as 2008 the lira had some of the highest overnight borrowing rates in the world at 16.75 percent, spurring carry trade. Although the bank had cut rates to 6.5 percent by early 2009, quantitative easing in western economies spurred renewed carry trade - inflating the lira. The central bank struck back by making the repo rate its main policy rate, and in November slashing the overnight borrowing rate to 1.75 percent from 5.75 percent - all but strangling foreign flows into overnight deposit accounts.