Burning through 30 billion in 3 weeks! Turkey's foreign reserves approach the red line, and concerns are rising as the central bank sells gold.

Ask AI · Can Turkey’s selloff of gold reserves effectively ease exchange-rate pressure?

Since the conflict erupted in Iran, Turkey’s central bank has splashed out billions of dollars to stabilize the exchange rate. Fund managers and economists are extremely skeptical: is Turkey really going to sell gold to replenish reserves……

Since the Iran conflict broke out, Turkey’s foreign-exchange reserves have fallen sharply. Fund managers and economists say, this has led people to question Turkey’s exchange-rate policy, and also suggests that the country’s central bank may have to tap its gold reserves to support the domestic currency.

Over the past three weeks, the rapid outflow of foreign capital has prompted Turkey’s central bank to spend about $30 billion to keep the lira stable—an amount that is nearly on par with what was spent during last year’s financial panic period, after Istanbul mayor İmamoğlu was arrested.

Aberdeen Emerging Markets Fund manager Kieran Curtis said: “At the current pace of foreign-exchange reserve losses, the central bank’s existing foreign-exchange policy won’t hold up for long, unless they sell part of their gold reserves.”

As a NATO member, Turkey shares a 550-kilometer border with Iran, and it is currently trying to end the conflict through mediation. Because the vast majority of its energy relies on imports, Turkey looks especially vulnerable in this conflict.

Last week, Turkey’s finance minister Şimşek candidly admitted that Turkey ‘can’t’ ‘stand apart’ in this conflict; what he’s most worried about is the problem of the current account deficit, and this weak spot could deal a heavy blow to the lira.

According to calculations by Bürümcekçi Research & Consulting based on official data, in the three weeks through March 19, Turkey’s central bank sold $26 billion worth of foreign exchange, bringing net foreign-exchange reserves to $43.4 billion after excluding forward transactions. Other independent economists estimate that since the conflict broke out, its net reserves have fallen by $34 billion.

However, data from JPMorgan shows that Turkey’s central bank still has gold worth more than $100 billion, about $30 billion of which is stored at the Bank of England. This gold can be used to intervene in foreign-exchange markets “without logistical constraints.”

Bloomberg reported on Tuesday this week that to replenish foreign-exchange reserves, Turkey’s central bank is considering using gold swap transactions. Gold swaps typically mean temporarily exchanging gold for foreign exchange and agreeing to reverse the transaction later to get the gold back.

Turkey’s central bank did not respond immediately to a request for comment.

Over the past three years, under the guidance of Şimşek—previously a senior economist at Merrill—and central bank governor Karahan—previously an economist at the Federal Reserve Bank of New York—Turkey has rebuilt its economic credibility.

The ultra-high interest rate and strong-currency policies they have pursued helped bring Turkey’s inflation rate down from the 85% peak at the end of 2022 to around 30% in January this year, and also rebuilt previously depleted foreign-exchange reserves. To a certain extent, this is thanks to Turkey’s current interest rate as high as 37%, which has attracted a large influx of foreign investors.

However, soaring energy costs are spreading to every corner of Turkey’s economy, which may weaken its tightening monetary policy—policies that were originally intended to suppress inflation, stabilize the lira, and maintain confidence among foreign investors and domestic savers.

Since the conflict erupted on February 28, the price of Brent crude has risen by more than $30 per barrel, hovering at around $102 this Tuesday. Last month, Turkey’s inflation rate climbed to 31.5%, among the highest in the world. At the same time, Turkey’s annualized current-account deficit has also risen to nearly $33 billion.

Timothy Ash, senior sovereign strategy strategist at RBC BlueBay Asset Management, said: “Turkey is holding up very well, and its performance has exceeded the expectations of many.”

Ash added: “However, the longer the conflict lasts and energy prices stay high, almost everyone can predict what will happen next: Turkey will have to let the lira go and raise interest rates. But if it gets to that point, the whole world will be dragged down with it.”

So far, Turkey’s central bank has been avoiding raising its main policy interest rate. This is very different from what happened in March last year. At the time, to calm the financial turmoil sparked by the arrest of İmamoğlu, the Turkish president Erdoğan’s biggest political rival, the central bank raised interest rates sharply by 3.5 percentage points to 46%, and poured in up to $50 billion to support the lira—causing net reserves to fall at one point to just $10 billion.

Since then, Turkey has rebuilt a foreign-exchange reserve buffer mechanism. Even so, if the economy weakens further, and on top of that a potential influx of Iranian refugees on a scale comparable to the nearly 4 million refugees who fled to Turkey during the Syrian civil war, all of this will make Erdoğan’s political prospects in the next presidential election even more complicated. The next election must be held before May 2028.

Polling shows that the ruling Justice and Development Party led by Erdoğan is currently slightly behind the largest opposition party, the Republican People’s Party led by İmamoğlu.