One week ago, the Turkish Lira which had flatlined for the better part of a month on what strategists said were an unprecedented array of novel capital controls and bank selling of dollars, suffered a sharp hiccup as local authorities briefly lost control of the currency, with USDJPY spiking briefly from its "pegged" level of 6.85 to as high as 7.00 before instantly reversing.
And while a precarious balance had returned in the subsequent few days, the lira resumed its gradual drift lower in what many saw an ominous deja vu of what happened in the summer of 2018 when the lira plunged only to see the central bank hike funding costs in an attempt to crush shorts.
Sure enough, with Turkey ostensibly running out of reserves to sell and keep the TRY quasi pegged, overnight Turkey resorted to the currency bazooka when it unexpectedly ramped up the interest rate on Turkish lira overnight swap transactions in the London market, which initially soared to 280% on Tuesday from 6.8% on July 29, according to Refinitiv data, before exploding as high as 1024bps, the highest on record.
Turkish banks have previously cut funding to the London swap market, effectively making it impossible to short the lira, in order to curb falls in the currency. Today's desperation move follows heavy dollar sales by state banks last week, which drained lira liquidity as the trades settle, Bloomberg said citing two traders.
Needless to say, for Turkey to resort to such draconian "Plan Z" measures where it effectively nationalizes the FX market, it means that its economy is on the verge of collapse, a view reaffirmed overnight by the FT which writes that Turkey's tourism sector - a key source of economic growth - continues to reel due to convid.
At this time of year, Murat Tugay, who runs the 240-room Hotel Aqua in the Mediterranean resort of Marmaris, should be dealing with a packed guestbook and all the challenges of peak season. Instead, the hotel is closed and Mr Tugay is banking on a late summer recovery. “We still have August. We still have September,” he says.
This implosion in Turkey's tourism sector comes at a time when President Recep Tayyip Erdogan has been desperately seeking to assure the population (and much needed foreign investors) that all is well, hailing a sharp fall in interest rates and praised measures taken to block “malicious” attacks on the Turkish lira. Such steps, he said, were “strengthening the immune system of our economy against global turbulence.”
That could not be further from how most economists see the Turkish picture. The collapse in tourism as a result of the coronavirus pandemic has left a gaping hole in the country’s finances. Foreign investors have fled, pulling out a large volume of funds from the country’s local-currency bonds and stocks over the past 12 months.
In the face of those outflows, the country has burnt through tens of billions of dollars of reserves this year in a bid to maintain an unofficial currency peg — a move that marks a rupture with a two-decade policy of allowing a free float. But, in a sign that those efforts are floundering, as we showed last week, the lira lurched towards a record low against the dollar even as authorities spent billions trying to defend it.
And now, it appears that Turkey is running out of reserves to sell and "control" the lira, and instead it is resorting to the bazooka approach, one which it can use to nuke the occasional short here and there, but which in the longer run will cripple the Turkish economy, and merely accelerate its downfall.
And sure enough, after the lira briefly strengthened in the spot market as a result of record surge in overnight rates, it then promptly swung to a loss again suggesting that it is no longer shorts that are in the driver's seat, that Turkey's paniced attempt to punish them will have little impact on the continued decline in the currency, and that a full blown currency crisis in Turkey may be about to hit.