After a week of public holidays in Turkey, the Turkish lira tumbled as traders returned with selling on their minds, realizing that nothing of substance has changed in the past 7 days. The currency tumbled over 4.0% against the dollar, sliding as low as 6.2974 before rebounding modestly to 6.23 as the U.S. trading day got underway, while one-month implied lira volatility jumped back toward 50%.
Turkey’s 10-year bond yield slipped 12bps to 22%, after touching a record high earlier this month.
As Bloomberg notes already poor sentiment remains crippled by double-digit inflation, a deepening current-account deficit and central banker reluctance to raise interest rates. While Turkey has raised rates by 500 basis points since April, it needs to boost them further by more than 600 basis points to stabilize markets, according to Societe Generale SA.
Turkey is also facing a potential recession, with JPMorgan revising its forecast for Turkey’s growth next year to 1.1% from 2.8%, as a result of "worsening financial conditions and tighter liquidity conditions... Coordinated policy action by the policy makers could put Turkey on a soft landing path where rebalancing is achieved with manageable collateral damage."
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Bloomberg's Mark Cudmore explains why Lira's problem are only set to grow as the country returns from its week-long holidays.
Turkey has only addressed the symptoms, not the cause, of its currency crisis. Efforts to shore it up notwithstanding, the lira is likely to see renewed pressure. Aggressive rate hikes are needed to attract inflows to fund the Turkish current-account deficit, estimated at 6.35% of GDP. And those don’t seem to be on the table right now.
True, the deficit should start to narrow given the lira’s depreciation, a slowdown in growth and an expected boost to tourism. But, it will be hard to build any enthusiasm toward the rebalancing story until the inflation/lira depreciation spiral is broken -- and that requires significantly tighter monetary policy.
So far, there’s been a stealth increase in rates, brought about by reverting to the 19.25% overnight lending rate from the 17.75% one-week repo rate. This amounts to an unofficial tightening, which could be extended by moving to the late- liquidity rate, currently at 20.75%.
That looks high, until you remember that July CPI printed at 15.85% y/y, and the lira is trading almost 20% weaker versus the basket since the end of that month. Inflation looks set to head north of 20%, implying the benchmark rate may be offering a negative real yield soon.
Negative real yields won’t attract the bond inflows needed to fund the current-account deficit and prevent the currency from weakening further.
Add to that the lack of liquidity, which has been exacerbated by capping banks’ swaps and non-swaps derivatives exposure to 25% of shareholder capital. The measure limits speculators’ ability to short the lira and has contributed to some stabilization of the currency. Unfortunately, it also drastically curtails the hedging abilities of long-term investors. This will discourage portfolio inflows for a long time to come.
Tensions with the U.S. show no sign of resolution. More sanctions will accelerate the currency crisis, though they won’t be the primary driver.
Some have pointed to the IMF as part of the solution, but it’s not necessarily required. Public sector debt to GDP is low and there’s unlikely to be a sovereign default -- although FX reserves at only $79 billion creates an extra concern.
According to IMF purchasing-power-parity metrics, the lira is now as cheap as the Indian rupee (which doesn’t have all the other economic problems.) But, until the inflation spiral/currency crisis is broken so that the country can roll its debt, any talk of “cheap valuation” for the lira is futile. Fix the underlying problems, and Turkey and the lira will be a great EM story again.