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Ratings agencies warn Turkey it may need to hike rates

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08/07/2020 | 01:24pm EDT

LONDON, Aug 7 (Reuters) - Ratings agencies warned Turkey on Friday that it will likely have to hike interest rates sooner or later as it runs out of options to defend the lira, which plumbed new depths against the dollar this week.

Ankara indicated on Friday it would use more backdoor policy tightening to try to stabilise the currency, one of the most troubled in emerging markets this year.

"Turkey has been muddling through for some time now, but muddling through is not a strategy that can be used forever. At some point they will run out of road," Sarah Carlson, lead sovereign analyst at Moody's Investors Service, told Reuters in an interview.

Maxim Rybnikov, associate director at S&P Global Ratings, said the central bank had already eroded Turkey's foreign exchange reserves this year, leaving limited room for manoeuvre there.

In an email to Reuters, he added that usable foreign exchange reserves were expected to drop below $10 billion this year from around $30 billion last year.

Many foreign investors have already fled Turkey, with non-resident participation in domestic government bonds at a record low of 4%, said Rybnikov, while official data showed foreign currency held by locals swelled to $212.92 billion at the end of July, continuing a trend of dollarisation.

"If domestic Turkish residents lose faith, starting to increasingly convert to FX, this can also precipitate a balance-of-payments stress," Rybnikov added, drawing comparisons with Azerbaijan in 2015 and more recently Argentina.

Moody's Carlson said policymakers had to weigh up embarking on reforms that may bring long-term gains but short-term economic pain, warning that hiking interest rates -- currently at 8.25% after a year-long easing cycle -- may not resolve underlying challenges.

"The fundamental problem is chronic shortage of domestic savings relative to investment needs in the country," she said.

Moody's was concerned about a rise in the ratio of government interest payments to government revenues, a key debt sustainability metric, said Carlson, describing it as a huge and rather unusual move.

President Tayyip Erdogan, who opposes high rates and sacked the last central bank chief for ignoring instructions, said on Friday the lira's volatility is temporary and the economy's main problem is fallout from the coronavirus pandemic.

His vice president said Turkey will overcome the "interest rate lobby” and FX “manipulation”. (Reporting by Tom Arnold Editing by Gareth Jones, Kirsten Donovan)

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