(Bloomberg) -- Turkey is draining lira liquidity at a record pace and has made it more expensive for banks to offer a tool designed to support the currency, as the government tries to shift to more market-friendly policies.

The latter move was announced hours after the central bank raised interest rates by less than expected on Thursday, but pledged alternative measures to counter inflation running at almost 40%.

Lenders will have to park more liras at the central bank to cover deposits under a program known in Turkey as KKM, according to an announcement in the Official Gazette published at midnight local time. The reserve requirement ratio will now be 15%. It was zero for deposits of six months and longer and 8% for those up to three months.

The stricter rule may draw as many as 450 billion liras (16.7 billion) from the banking system.

KKM was set up in 2021 amid a currency crisis and had attracted almost 3 trillion liras of savings as of July 14, according to official data.

It promises a state-guaranteed return on lira deposits that at least matches the currency’s declines against the dollar. Its introduction was criticized by many investors as adding to the labyrinth of market controls introduced under President Recep Tayyip Erdogan.

The central bank has separately withdrawn record amounts of money from the banking system this month to reduce lira liquidity. It was a net borrower of liras via open market transactions for a fourth straight day on Wednesday, according to data compiled by Bloomberg.

After raising its benchmark rate by 250 basis points to 17.5%, the central bank said it would also introduce “quantitative tightening and selective credit tightening” to rein in excess liquidity in the market. The hike was smaller than what most economists expected, with some saying it was too little to support the lira and fight inflation.

Economic Shift

Erdogan won reelection in May and has since pledged a return to more orthodox policies in a bid to attract the billions of dollars of foreign investment he needs to end a cost-of-living crisis and rebuild Turkey’s dwindling reserves.

The president appointed former Merrill Lynch bond strategist Mehmet Simsek as finance minister in June. Simsek expressed strong criticism of KKM in a private meeting with foreign investors earlier this month, describing it as a bad idea that’s created significant challenges, Bloomberg reported.

The Treasury denied Bloomberg’s report and referred to Simsek’s previous comments in which he said the government would continue making lira-denominated banking instruments “attractive.”

The problem with shutting KKM down is that it can add to pressure on the lira — and the central bank’s reserves — if large numbers of savers choose to convert back into dollars as an alternative.

The lira is already among the worst performing currencies among emerging markets peers this year, losing 31% of its value against the dollar. It was trading 0.6% weaker at 26.94 as of 5 p.m. Istanbul. 

(Updates with lira rate. An earlier version corrected the deposit rate in third paragraph.)

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