The foreign exchange outlook remained bleak on 26 January, as MEED went to press, with banks and economists doubtful about the government's ability to contain a developing run on the lira. An early casualty has been Prime Minister Tansu Ciller's low interest rate policy.

Concerted action by the treasury and the central bank introduced some temporary calm into Turkish financial markets. The markets had been panicked into a run on the lira by the mid-January risk downgrading by the US agencies Moody's Investors Service and Standard & Poor's (MEED 28:1:94, page 35). But, by 26 January, the lira was on a downward slide again.

The lira slumped to its weakest interbank level of $1=TL 18,500 on 20 January, recovered to $1=TL 16,500 on 24 January, but slipped to a wide range of $1=TL 17,300-17,700 on the interbank markets a day later. Over the period, the lira lost 6.4 per cent of its dollar value, while the spread between interbank and official rates grew to 17 per cent.

The run was initially checked by high interest rates on treasury bill offerings, and short-term rates of up to 180 per cent from the central bank, which temporarily attracted excess liquidity away from foreign exchange. But the emergency moves made nonsense of seven previous cancellations of treasury bill issues when banks refused to fall in line with the treasury's drive to cut interest rates and translate its short-term borrowing burden into medium and long-term debt.

There is a limit to the extent to which the central bank can erode its reserves through market intervention, even though these still remain at record levels. It is becoming increasingly reluctant to do so, but its failure to mop up excess lira is likely to fuel a new speculative assault on the currency.

Soaring interest rates have also drawn funds away from the Istanbul stock exchange, where the index declined by 15.9 per cent between 23-25 January to close at 22,727.21.

International banks are adopting a wait-and-see attitude for the next three to four months. The downgrading had been expected, and was built into pricing for recent deals. 'The markets were already according Turkey a BB rating, which is where the agencies ended up,' says a banker. 'They were effectively reflecting market sentiments.' Market rates had been comparatively high and had lowered little since the Gulf crisis.

However, international banks are expected to re-evaluate the medium-term risk, resulting in a reduced role for Turkey in bank lending portfolios. Syndications will be more affected than bond issues. There was a flurry of trade-related syndications at the end of the year before the ratings verdicts were announced. A reduction in credit lines for facilities such as letters of credit has been most noticeable amongst German institutions, according to one banker.