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Apr 16 2018

Combative Erdoğan set to lose battle with investors over lira

Turkish President Recep Tayyip Erdoğan is warning foreign investors against using the lira as a means to pressure his government to slow the pace of economic growth.

Erdoğan said last week that “no one could bring Turkey to heel using exchange rates”, in a seemingly direct challenge to investors who have been selling the currency in recent weeks.

"Those who are in the finance sector, don’t threaten us with exchange rates or similar things," he told his supporters on Sunday. "You will not have right to life in this country otherwise.”

Turkey’s combative president, overseeing emergency rule in the country since a failed military coup in 2016, is used to getting his way domestically and is depicting opposition to his economic policies from abroad as a conspiracy against Turkey. But while such rhetoric may play well with his supporters, a battle with the international investment community is one he is unlikely to win.

The lira slumped to a record low against the dollar and euro last week on fears that Erdoğan’s focus on economic growth, to the detriment of inflation and the trade balance, is overheating Turkey’s import-hungry economy, which grew 7.3 percent last year. Erdoğan and his ruling Justice and Development Party (AKP) face re-election by November next year.

Current account data for the month of February, published last week, showed an outflow of direct investment from Turkey’s economy for only the fifth time in the past decade. Furthermore, inflows of foreign capital into Turkish stocks and bonds have reversed, suggesting that government policy may be prompting a flight of capital from the $850 billion economy.   

As the lira slumped to a record low of 4.17 per dollar, the stock market has lost $20 billion of its value in the past two weeks. The main BIST-100 index has crossed below its 50-, 100-, and 200-day moving averages within three weeks, signaling that the negative trend may be taking hold.

Furthermore, yields on Turkey’s benchmark 10-year lira bonds breached 13 percent, the highest level since the financial crisis and almost 200 basis points more than they were at the start of the year. Rising rates in the bond market are being reflected into the loan market, with interest rates on cash loans for consumers approaching 20 percent.

Erdoğan is insisting that his government will ride the storm in financial markets with the help of higher exports, which the government expects to exceed $170 billion this year. But Turkey’s reliance on foreign raw materials and intermediate goods has seen imports increasing at a faster pace than exports, meaning efforts to rebalance the economy through foreign trade are set to fail without a serious decline in domestic demand. Consequently the current account defict has more than doubled to $30.2 billion in the first two months of the year as imports surged 30 percent.

Such a decline in demand may be what Erdoğan gets should the lira continue to post fresh lows. Consumer confidence in Turkey, which had reached an eight-month high in January, is now dropping once more. Business confidence, meanwhile, has slid to 100.2 in March from 104.9 in January, the biggest two-month fall in more than a year.

Furthermore, the construction industry, for so long a driver of economic growth, and indeed fortune for Erdoğan’s business allies, is showing signs of severe stress. Confidence among the nation’s house-builders is a mere 78.9 – a reading below 100 indicates pessimism about the future.

All market and economic indicators are therefore pointing toward a correction for Turkey’s economy, which now appears to be running on fumes.

Rather than keeping his foot on the gas – Erdoğan announced $34 billion worth of investment incentives to 19 companies this week to stimulate growth further – the government would be well advised to turn its attention to cooling the economy down through what now appear to be unavoidable hikes to benchmark central bank interest rates.

Turkish Central Bank Governor Murat Çetinkaya
Turkish Central Bank Governor Murat Cetinkaya

Market rates suggest that the central bank will need to increase its highest interest rate, which is a mere 11.75 percent, to the tune of 350-400 basis points to avoid a much greater move later. But evidence shows that the bank will be slow to act.

History suggests that the lira may need to decline to at least 4.25 to the dollar to prompt action from Central Bank Governor Murat Çetinkaya, an Erdoğan appointee and former Islamic banker. The bank had previously allowed the currency to slump more than 30 percent in 2016 and over 20 percent in 2015 before acting.

It was peculiar to see Erdoğan challenging foreign investors at the weekend when the slump in the lira had appeared to reverse. The currency traded at 4.1 per dollar on Monday, thanks partly to a reduction in tensions between the United States and Russia over neighbouring Syria.

Erdoğan claims that there is no rational basis for the slump in the currency’s value, but the problems for Turkey lie much deeper than regional politics. Foreign investors are becoming pickier about where to put their money as global liquidity tightens, and Erdoğan’s combative words will do little to reverse deteriorating sentiment towards Turkey.

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