* Locals' foreign currency holdings up sharply this year
* Rise suggests central bank may struggle to defend lira
* Central bank reluctant to hike interest rates
* Limited shelf life of Fed stimulus also weighs on lira
* Turkey has to attract some $225 billion to fund short-term debt
ISTANBUL, Nov 14 (Reuters) - Turks are hoarding dollars and shunning their own currency as confidence in it dwindles, undermined by high inflation, a cloudy political outlook and fears of an exodus of foreign investors.
Locals have in recent years tended to provide a leg of support for the lira, buying it on dips and selling it during periods of strength.
But that balance appears to have swung more decisively in the dollar's favour, with Turkey's foreign exchange deposits - those held by households and companies as well as remittances from abroad - having risen almost 10 percent to $150 billion over the past six months.
That eclipses the central bank's own forex reserves of $112 billion.
If the trend continues, the effect could be to further dampen the supply of dollars in the local market, leaving the lira even more vulnerable when the U.S. Federal Reserve finally starts to wind down its $85 billion a month stimulus programme, economists say.
"Turkish households have been accumulating forex deposits recently, rather than selling their forex in periods of lira weakness as they tended to do in the past," Barclays said in a recent note to clients.
"This could dry up a local source of forex liquidity at a time when the corporate sector's forex exposure is higher than ever. It could leave the lira more exposed to global liquidity conditions."
Scarred by hyperinflation, which touched 125 percent in the mid 1990s, Turks still shy away from making long-term lira deposits even though inflation, in relative terms, has long been under control, currently running at around 7.7 percent.
Distrustful of their volatile currency, Turkish households and companies for years behaved like currency traders, dealing in the currency and at the same time helping to smooth out fluctuations in exchange rates.
After the collapse of Lehman Brothers in 2008, Turks sold some $20 billion of their forex holdings as the value of the lira plummeted by around a quarter.
BETTING AGAINST THE CENTRAL BANK?
But with an election cycle due next year, they now seem more inclined to follow bets that the central bank will have a hard time defending the lira, hedging themselves against that risk.
"In the past, those who remained in the lira always won in the long term, but I'm not so sure anymore," Murat Ucer, an analyst at Istanbul-based investment consultancy Global Source Partners, told Reuters.
"The central bank has made clear its preference and revealed a real exchange rate target. This reminds me of the 1990s when the lira was depreciating as much as the rate of inflation," he said, noting the stabilising effect of households' forex sales had disappeared.
The lira fell some 15 percent between May, when the Fed first signalled it may start tapering its stimulus programme, and early September, when it hit a record low of 2.0840 against the dollar.
It has since partly recovered, trading at around 2.05, but remains some way off the 1.92 level that Central Bank Governor Erdem Basci forecast it may reach by the end of the year.
Basci set himself a huge credibility test when he made the forecast in August, vowing at the same time that the bank would not hike interest rates to support the local currency.
The accumulation in forex deposits suggests Turkish savers and companies are not giving him the benefit of the doubt.
"The central bank has been proven wrong. Nobody believes the lira will be 1.92 to the dollar. If it is so attractive why are foreign investors not coming? Because they dislike the level of interest rates," said a senior banker who declined to be named.
"When the central bank's predictions do not materialise this weakens its credibility and exacerbates investors' reactions."
The bank has stuck to the pledge not to defend the lira with interest rate hikes, keeping its main one-week repo rate on hold at 4.5 percent since April - well below the rate of inflation - and betting on support for the lira from a delay in any trimming of U.S. monetary stimulus.
It is expected to leave all of its main interest rates - including its borrowing rate at 3.5 percent and its lending rate at 7.75 percent - on hold when the monetary policy committee meets on Tuesday, according to a Reuters poll of 12 economists.
Because it imports almost all its energy, Turkey has been running a large current account deficit which makes it particularly susceptible to a withdrawal of central bank stimulus, which has driven emerging markets asset demand over the past year.
The private sector's short-term foreign-denominated debt stands at around $165 billion. Coupled with an expected year-end current account deficit of just under $60 billion, this means Turkey has to attract some $225 billion to fund short-term debt.