Selva Demiralp

Selva Demiralp is a professor of Economics at Koç University, Istanbul, teaching monetary policy and central banking. selvademiralp.com

Economist Selva demiralp analyses the chances of Turkish Central Bank’s getting a positive response to open a swap line with the Fed. (Photo: Fed website)

Emerging markets’ currencies depreciate rapidly during times of crisis. This is because the risk appetite declines during crisis and emerging markets experience capital outflows. Those with macroeconomic imbalances are affected the most.
Because Turkey was far from achieving price stability when COVID-19 crisis hit, it is experiencing more problems on the currency front. The rate cuts to stimulate the economy trigger Dollarization. When market interest rates decline below the inflation rate, depositors lean towards the Dollar to protect the purchasing power of their savings. Thus, TL depreciates due to a decline in the supply of Dollars as well as an increase in the demand for Dollars.
As the depreciation in TL accelerates, the prospects of a swap line with the Federal Reserve once again become a hot topic of discussion. A swap agreement allows the currencies of the two central banks to be exchanged. Swap agreements established by the Fed last for up the three months. If you borrow, say $10 billion and the USD/TL exchange rate is 7 TL, then you give 70 billion TL to the Fed. At the end of three months, you pay $10 billion back with interest. Thus, a swap line can provide temporary relief for an economy that is in need of foreign exchange. Yet, what are the chances that the Fed could extend a swap line to Turkey?

No answer given yet

Bloomberg reported on April 10 that Turkey seeks swap lines with G20 countries including the US. On April 19, this time CBRT governor Murat Uysal stated that Turkey has been talking to G20 countries to establish bilateral swap lines. Nevertheless, there was no announcement of a new swap line in the weeks that followed.
In response to a question about whether the Fed would extend a swap line to Turkey, Richmond Fed President Thomas Barkin said on May 6 that swap lines do not cover all the countries and that the Federal Reserve established swap lines with countries based on “mutual trust” and the highest credit standards.
Barkin’s answer gave the impression that the Fed considers swap applications by different countries including Turkey, and yet Turkey is not considered trustworthy enough to be granted a line. Combined with Uysal’s speech on April 19, Barkin’s answer suggests that Turkey is deemed to be unqualified based on a recent evaluation. However, when we investigate the list of countries who are granted a swap line by the Fed, we observe that this is not a list that is actively updated based on current needs or developments. Instead, the list was formed after the 2007 crisis and has not changed since then.

Fed criteria for a swap line

The swap lines were established after the Great Recession in 2007-2009. The Fed authorized these lines to prevent the global demand for Dollars from causing any additional stress in US markets. The idea was to maintain the flow of credit to US markets.
Since 1994, the Fed has had swap agreements with the central banks of Canada and Mexico. After the Great Recession, the Fed added the following central banks to the list: European Central Bank, the Reserve Bank of Australia, the Banco Central do Brasil, the Bank of Canada, Danmarks Nationalbank, the Bank of England the Bank of Japan, the Bank of Korea, the Banco de Mexico, the Reserve Bank of New Zealand, Norges Bank, the Monetary Authority of Singapore, Sveriges Riksbank, and the Swiss National Bank.
Even though the money printed by the Fed is a global reserve currency, the Federal Reserve who prints Dollars is not the central bank of the world. The Fed is the central bank of the US. Thus, its primary focus is the US economy. The legal mandate of the Fed is to establish price stability and maximum employment in the US. Any step taken by the Fed has to be consistent with this mandate. The purpose of swap lines is to prevent any stress in foreign markets to be transmitted into US markets and ensure that the global wheels are turning. Other than that, the Fed is not authorized to fund a particular country.

Not very likely due to the current list

When we take a look at the list of countries that are granted swap lines we observe that the list is identical to that prepared during the 2007 crisis. Thus, it does not seem likely for Turkey or any other country that is not in the original list to be granted a line by the Fed.
It seems like the Fed had made its mind about which countries were eligible for a swap line a decade ago and this list is not subject to negotiations based on current developments. Thus, one should not consider Barkin’s comments as a reflection of the current tension between the US and Turkey. Rather, the underlying reasons must be based on factors that existed a while back. That being said, if the Fed updates the list of countries and includes new countries while still excluding Turkey, then the story would change and we would need to re-evaluate Barkin’s comments.