(Bloomberg) -- Turkey’s central bank, once criticized for selling reserves to prop up the lira, is now trying to do the opposite to prevent the currency from gaining too much.

But a remedy for what Finance Minister Mehmet Simsek has called excessive appreciation is flooding the financial system with hundreds of billions of liras in liquidity that the central bank now has to mop up. Its foreign-exchange purchases totaled $43 billion in the past four weeks when adjusted for valuation effects, according to Goldman Sachs Group Inc. 

The result is a managed currency that resembles the Chinese yuan and the Indonesian rupiah, according to SEB AB. Since a slump before local elections in March, the lira is up only about 0.4% against the dollar, compared with a gain of well over 2% for a peer like South Africa’s rand.

“The problem facing the Turkish central bank has moved from FX weakness to the difficulty of avoiding a nominal appreciation amid rising foreign inflows and a more favorable current account seasonality and of sterilizing its FX purchases,” said Goldman economists Clemens Grafe and Basak Edizgil. 

Pressure on the lira to appreciate is itself a side-effect of domestic interest rates that are the highest among the Group of 20 nations, as policymakers try to get a handle on price growth in excess of 70%. 

Central bank Governor Fatih Karahan said on Friday that monetary policy would have to be tight until inflation expectations fall, with rate cuts penciled in by most economists for no sooner than the final quarter of the year. 

The outlook has created a massive arbitrage opportunity for investors who borrow where rates are low to invest where they are high. Turkey’s inflows related to carry trade are up by about $16 billion since the March local elections, Bloomberg Economics estimates.

According to Goldman, foreign inflows will continue as long as elevated inflation expectations delay rate cuts. That’s putting the lira under “significant appreciation pressure, even though the currency is not cheap in real terms,” the economists said.

What Bloomberg Economics Says...

“The lira’s muted second quarter, coupled with interest rate differentials that are likely to widen further in its favor, suggests a relatively stable currency outlook. As such, we expect Turkey’s carry trade inflows to continue to grow in the near term.”

— Selva Bahar Baziki, economist. Click here to read more. 

Capital seeping into Turkey is allowing the central bank to build back its depleted stockpile of hard currency. But it hasn’t been fully withdrawing the liras being pumped into the economy, forcing policymakers to introduce sterilization measures after keeping rates on hold on Thursday. 

Another concern is that a “controlled lira” creates “distortionary incentives for higher imports,” according to Erik Meyersson, SEB’s chief emerging markets strategist. “Coupled with the relatively limited central bank reserves, this approach may not be sustainable in the long term,” he said in a research note. 

(Updates with lira’s performance in third paragraph.)

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