(Bloomberg) -- Turkish officials have been holding talks in recent weeks about easing restrictions on offshore currency swaps, according to people with knowledge of the conversations, a move that would meet a key demand from foreign investors interested in entering the market.

The details of when and how such easing could take place have yet to be determined and officials are likely to take steps gradually, the people said, asking not to be named because the discussions are private.

One preliminary plan would involve loosening restrictions for longer-maturity contracts first to avoid unwanted volatility in the Turkish lira, one of the people said. The time frame will be determined by factors including actual inflation rates and changes in prices expectations, the person said.

The Treasury and Finance Ministry, central bank and the banking watchdog BDDK declined to comment.

Turkish banking stocks rallied after the news, erasing earlier losses, while the benchmark stock index ended the session 0.7% higher, also after an earlier drop. The country’s 5-year credit default swaps tightened about 10 basis points to 282 basis points, the lowest since February 2021.

 

Tim Ash of RBC Bluebay Asset Management in London said via email that if the plans do materialize “it sends a positive confidence shock and by better helping international investors hedge their lira exposure it will make them more willing to invest. Easier done when the market is generally bullish lira assets - as at present.” 

Easing limits on the swaps that Turkish banks can extend to foreign counterparts would be a significant step toward opening the market to foreigners. The daily average volume of lira trading on the London spot market was around $5.2 billion as of 2023, according to Bank of England data.

The regulations have been one of the main obstacles to investing in Turkish assets because they make it difficult to hedge against currency risks. Broader limits for local banks give them access to cheaper funding.

The rules were implemented under previous economic administrations in an effort to prevent short-selling of the lira by restricting access to liras overseas. Short-selling refers to the practice of borrowing an asset for a certain time period, and selling it in expectation of the value going down. 

Initially, Turkish banks and financial institutions were limited to extending 1% of their equity capital to overseas counterparts in the form of currency swaps, options, futures, forwards and other derivative contracts. The limit has been eased from time to time and also changes according to different maturities.

Officials have come under growing pressure to begin lifting the limits amid growing demand abroad for liras, with some local lenders hitting their allowed swap limits. Removing swap restrictions now would allow local banks to buy liras cheaply and reduce excess liquidity in the market.

An increase in long lira positions abroad in recent weeks has caused a divergence between onshore and offshore rates for borrowing liras, with offshore overnight rates dropping to 28% as of Tuesday — compared with the domestic yield of nearly 53%. That hurts the currency’s carry appeal, as lira carry traders abroad earn only about half what they would earn in Turkey.

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