Mark Bentley
May 30 2018

Turkish currency volatility beats Argentina’s as jitters persist

Turkey’s lira is more volatile than the embattled Argentinian peso as uncertainty persists about its real value and emerging markets suffer from adverse global developments.

An index by V-Lab showed lira volatility at 30.9 percent, more than double that of the Polish zloty (14.8 percent) and the Russian rouble (14.1 percent). Peso volatility was 29.8 percent. The index measures the strength and frequency of swings in the price of a currency.

Concern about the lira remains elevated even after a 300 basis-point rate hike by the central bank to 16.5 percent last week. Investors in Turkey are trying to predict likely economic policy following June 24 presidential elections, as well as the impact of a recent slump in the lira on inflation of 10.9 percent and a current account deficit that has widened to more than 6 percent of economic output.

The lira has swung between gains and losses over the past few days as economists and strategists digested the impact that rate increases might have on currency weakness and an economy growing at about 7 percent annually after a raft of government stimulus measures. Turkish Economy Minister Nihat Zeybekçi said this week he expected the economy to grow faster than 7 percent in the first quarter after similar growth last year.

While the central bank also simplified its monetary policy on Monday - a move widely welcomed by investors - it has still left room for flexibility in interest rates by retaining its unorthodox “interest rate corridor”.

 In the past, the bank has been accused of pandering to the governments’ wishes and growth-driven economic policies by focusing on multiple interest rates and therefore undermining the effectiveness of the benchmark rate in taming inflation.

Concern that President Recep Tayyip Erdoğan, who says higher interest rates are inflationary, is interfering in monetary policy has contributed to big losses for the lira this year. Credit ratings agencies and some investors have said Erdoğan’s increasing stranglehold over policy will accelerate after the elections, making economic policy more difficult to predict.

Erdoğan’s comments to bankers in London earlier in May - he said his government planned to lower interest rates should he win the June election - helped prompt a one-day sell-off of more than 5 percent in the lira to a record low of 4.92 per dollar on May 23.

The central bank raised interest rates later the same day to ease fears about a fully fledged currency crisis. The lira has lost about 17 percent against the dollar this year and 11 percent in May alone. Argentina's peso was the only major currency to lose more value after the country was forced to sign an International Monetary Fund rescue deal to stave off a financial crisis.

The damage that Erdoğan’s comments have caused to Turkey’s reputation as a safe and predictable place to invest will take some time to repair, economists and analysts have warned. He and his ruling party lead in opinion polls ahead of the June 24 presidential and parliamentary elections.

The Turkish central bank’s unorthodox monetary policy, which replaced an inflation targeting regime in late 2010, has had very mixed results - inflation has accelerated into double digits and the money supply has increased markedly, hurting the value of the lira.

Goldman Sachs is one of several foreign banks that welcomed the central bank’s move to partially simplify monetary policy this week. The one-week repo rate has now become the benchmark lending rate of 16.5 percent, with other borrowing and lending rates varying each way by 150 basis points, respectively.

The central bank’s decision was important because it showed that the bank has independence from politicians while retaining some flexibility to alter interest rates when needed, Goldman Sachs said in a report on Monday.

The move by policymakers may be a step in the right direction, but “there is no need for multiple rates”, said Tim Ash, senior emerging markets strategist at Blue Bay Asset Management in London.

“Turkey needs plain vanilla and independent central banking,” he said.

Turkish Deputy Prime Minister Mehmet Şimşek and Central Bank Governor Murat Çetinkaya held meetings with investors in London this week to try and repair the fallout from Erdoğan’s comments about interest rates. They pledged more rate increases if needed. The lira gained 1.1 percent to 4.4911 per dollar early on Wednesday.

Steve Hanke, professor of applied economics at John Hopkins University, pointed out that Turkish monetary policy has been “too loose for too long”, in an analysis for Forbes magazine’s latest edition.

While inflation in Turkey is officially 10.9 percent, a study of the effects on Turkish prices caused by the lira’s decline since Erdoğan became president in 2014 – totalling 56 percent -- showed an annual rate of 39.2 percent, Hanke said.

Hanke, who has advised dozens of world leaders on currency reform and how to tame hyperinflation, used purchasing power parity (PPP) to translate changes in the lira-dollar exchange rate into annual inflation.

The supply of money in Turkey is also expanding too quickly, growing at an annual rate of 16 percent since 2014 and 18 percent since 2016, Hanke said. That compares with the 13 percent growth needed to meet the central bank’s inflation goal of 5 percent.

Interest rates would need to increase to more than 40 percent to attract some investors back to lira assets, he said, pointing to Japanese carry-traders who borrow cheaply in yen to fund purchases of lira assets that return far higher rates of interest.

Returns on two-year Turkish lira debt are about 16.5 percent annually, without subtracting the value-eroding effects of currency depreciation or inflation. Ten-year bonds yield 13.5 percent.

On Tuesday, Cemil Ertem, Erdoğan’s senior economic adviser, said it was unfair to characterise Turkish economic policy as unpredictable or too growth-focused.

Steps taken by the central bank this week to simplify monetary policy prove its independence and should end criticism that its policy framework is too complex or loose, he said.

While the central bank should operate independently, it also needs to embrace the common aim, shared by the government, of increasing economic prosperity and living standards in the country, Ertem said.

 

The opinions expressed in this column are those of the author and do not necessarily reflect those of Ahval.