A scheme Türkiye adopted a year ago aimed at protecting Turkish lira deposits from depreciation versus hard currencies has contributed to the strengthening of financial stability and has curbed foreign exchange demand, a top official said Monday.

The government introduced the state-backed scheme, known by its acronym KKM, on Dec. 20, 2021, to stem a steep depreciation in the lira, a decline that Treasury and Finance Minister Nureddin Nebati says was "incompatible with market reality."

The initiative sought to keep dollarization at bay and curb demand for foreign currency by compensating depositors for lira losses against foreign currencies.

The lira declined 44% last year and lost some 29% versus the United States dollar this year but has held mostly stable since August.

"In the last months of last year, we observed unhealthy price formations and fluctuations in exchange rates that were incompatible with market reality," Nebati said in a statement marking a year since the scheme was launched.

Nebati said the scheme was launched to prevent what he said were developments that "reached a size that threatened financial stability."

The scheme aimed at encouraging foreign currency holders to convert their funds to lira. The deposit accounts offer substantially higher interest rates and a guarantee, backed by the central bank and Treasury, against potential exchange rate losses.

A presidential decree published in Saturday’s edition of the Official Gazette amended the deadline for opening new KKM accounts to Dec. 31, 2023.

Nebati said the application sought to "prevent our citizens who evaluate their savings in Turkish lira-denominated accounts from being negatively affected by changes in the exchange rate and to strengthen their trust in our financial system."

Nebati also cited the role of the scheme this year, marked by major global and regional challenges, spearheaded by interest rate hikes, pioneered by the U.S. Federal Reserve, and Russia’s invasion of Ukraine.

The scheme made "significant contributions to strengthening financial stability, limiting the demand for foreign currency and extending the maturity of Turkish lira deposits," the minister said.

Despite all the challenges, the governments’ policies paved the way for a 21-percentage-point decrease in the share of foreign currency deposit accounts in total deposits, Nebati added.

He underscored that the scheme also made a positive contribution to the country’s macroeconomic balances and played an important role in the "growth of economic activity on solid foundations."

Budget payments near $5 billion

The budget payments into the KKM reached TL 91.6 billion ($4.91 billion) this year, Nebati said, stressing that the government continues to share the cost of the scheme "with transparency."

Meanwhile, the Turkish central bank’s net international reserves leapt some $3.6 billion to $26.76 billion in the week ending on Dec. 9, hitting their highest level this year, data showed last week.

In July, the net forex reserves dropped to $6.07 billion, their lowest in at least 20 years, but since rebounded.

"When the instruments and measures we have implemented since December 2021, especially the KKM, are evaluated from a holistic perspective, they have played an effective role in maintaining financial stability," Nebati said.

The Turkish government over the last 14 months prioritized low interest rates to boost exports, production and investment and create new jobs as part of an economic program, which eventually aims to ensure a lasting fall in inflation by flipping the country’s chronic current account deficit to a surplus.

Last month, the country’s central bank wrapped up the easing cycle that saw it lowering its benchmark policy rate by 5 percentage points since August to 9% from 14%, in line with President Recep Tayyip Erdoğan’s calls for stimulus.

The central bank says cuts were necessary given the signs of economic slowdown.

Stance against interest rates policies

Erdoğan says high rates cause inflation and he had called for single-digit rates by year-end. He has said the government’s new economic model is expected to yield results in the new year.

Officials, including Nebati, have said the country’s new model refuses the doctrine that policy interest rates should be higher than inflation to curb price increases.

"Our strong and determined stance against the interest rate policies that were easily imposed on us in the past not only reflects positively on the macroeconomic indicators of our country but also allows for solving chronic problems," Nebati said Monday.

He stressed the KKM scheme was launched at a challenging time, marked by the high volatility in the exchange rate, as well as many other factors that Nebati said threatened the country’s economy, spearheaded by rising uncertainty in the global economy and post-pandemic supply bottlenecks that fueled cost inflation.

Price increases in Türkiye moderated in November, according to official data, signaling that inflation pressures that have been plaguing consumers for about a year and a half might be finally easing.

Annual inflation dropped below 85% last month after touching a 24-year high in October. It is expected to decline sharply as a result of the base effect at the end of the year and falling energy prices globally.

While the whole world is rapidly heading toward a recession as a result of what Nebati said was rising inflation, interest rates and the foreign exchange rate's vicious cycle, he stressed that the government is "continuing our fight against inflation with a people-oriented approach by increasing employment by going beyond the economic impasse with the contribution of this initiative."

"We anticipate that the cost of the KKM, which compared to its limited cost supports increasing predictability and accelerates the downward trend in inflation, will remain limited in the coming period as well," Nebati said.