Turkish central bank struggles with undervalued lira

Fear of another global recession has muted criticism of the Turkish central bank's low interest rate strategy and silenced calls for higher rates, but despite greater market backing it will struggle to get the ailing lira back to desired levels.
Central bank Governor Erdem Basci said this week the lira is around 5-10 percent undervalued against the euro-dollar basket, and that the bank has strong tools at its disposal to support the currency.
His comments, made when the basket hit levels of around 2.16, helped to answer a question which has troubled markets since the central bank launched an unorthodox new policy mix last December - just how far does the bank want the currency to depreciate.
Late last year the bank set about weakening the lira in order to make Turkish exports more attractive and to curb surging imports, which have driven the current account deficit to alarming highs. But the currency has now overshot a level of around 2.00-2.10, which the bank has increasingly hinted is its threshold.
"The central bank never gave a clear signal before about the level of the lira. But now they sent a clear message to markets that they don't want the lira to depreciate further," said Murat Toprak, a foreign-exchange strategist at HSBC in London.
"I believe they want to stabilise the lira around 1.75 to the dollar. They look worried about the global environment due to Turkey's current account deficit and the way it is funded ... As for the basket, the 2.00 level is a psychological barrier."
Since the start of August the lira has lost 5 percent of its value versus the 50/50 euro/dollar basket, tracked closely by the bank as the euro zone is Turkey's largest export partner attracting 48 percent of exports. Losses since the start of 2011 amount to a staggering 20.3 percent, making the lira one of the worst-performing emerging market currencies this year.
The bank's introduction of daily forex-selling auctions on August 5 which it has increased in size, a 350 basis point increase in the overnight borrowing rate, and verbal interventions by Governor Erdem Basci have all so far failed to help the lira to gain traction. The lira touched its weakest level to the basket of 2.2115 on Tuesday.