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    A slight divergence from pure floating exchange rate regime

    Fatih Özatay, PhD03 October 2010 - Okunma Sayısı: 1042

     

    On Friday the Central Bank announced an important decision on FX purchase tenders. In the former system, daily purchase limit was US$80 million. The announcement said: "In case of strong capital inflows, the Central Bank can raise the quantity in regular FX purchase tenders in order to accelerate FX purchases." And continued: "...when such a decision is made, the extra quantity to be purchased within the following week will be announced on the first workday of the relevant week."

    So, the Bank will initiate additional purchases above US$80 million daily limit in order to accumulate reserves. And the amount of additional purchase for the week will be announced at the beginning of that week. Thus arises a significant window of flexibility: The bank can purchase FX at any amount. This is not the only aspect of flexibility the new system introduces. At the beginning of the week, the maximum amount of additional purchase is announced, but it is yet not known exactly how much of this amount will actually be purchased. For instance, if the bank announces the maximum additional purchase at US$500, the tender to be opened by the Bank that week can be US$20 million or US$500 million.

    There also is a third window of flexibility. The bank can open a tender for US$100 million on Monday, skip Tuesday and Wednesday and open a tender for US$400 million on Thursday. Because, daily limit is not known in advance but decided on the day when the tender will be carried out.

    It is not over. We have a fourth one: Say, the maximum amount to be purchased this week is announced. For the week after and even for an indefinite time there is the possibility that no tender is opened. But consecutive tenders each week are also possible.

    There are types of floating exchange rate regimes. On the one end is the pure floating exchange rate regime. And on the other end is a 'so-called' floating exchange rate regime in which exchange rate is determined by interventions rather than by market conditions. And in between are various combinations of these two ends.

    The former system was quite close to pure floating exchange rate regime. When you add all these up, you will come up with the conclusion that the new system slightly diverges from the pure regime. It is in between the ends. And implementation practices will tell us to which end the system is closer to.

    There is another interesting issue about the decision. Though I do not believe that the Bank has such an intention, the decision allows the Central Bank to reduce amount of FX purchased compared to the former system. The story goes like this:

    The Bank can open additional purchase tender everyday but for quite low amounts. For instance, the Bank can purchase US$5 million per day with this method. In that case, since the US$40 million option will be off the table, maximum purchase amount per week would be US$225 million. But in the former system, this figure could have gone up to US$400.

    But let us skip this logical possibility. The new decision furnishes the Central Bank with a new tool to deliver message to the market. This message is about how the additional system will be used. The Bank can act both aggressively or moderately in the FX market. We will learn which one each week when the amount of additional purchase is announced.

     

    This commentary was published in Radikal daily on 03.10.2010

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