Mark Bentley
Mar 29 2018

Lira sacrificed as Turkish economy steamrolls into 2018

Turkey’s economy is steamrolling into 2018 after growth of 7.4 percent last year, the highest in the G20 group of industrialised nations.

Turkey’s GDP expanded an annual 7.3 percent in the fourth quarter after 11.3 percent growth in the previous three months, the statistics agency said on Thursday.

But President Recep Tayyip Erdoğan’s government is stimulating the economic expansion at huge cost, not least to the earnings power of the average Turkish citizen, as the lira slides and inflation surges.

The lira is near a record low against the dollar, inflation of 10.3 percent is the highest in emerging markets and the current account deficit is equal to 5.6 percent of GDP, the widest among Turkey’s peers, as a surge in imports far outpaces exports.

Economists say something will eventually have to give.

In a statement on Twitter on Thursday, Hatice Karahan, a senior economic adviser to Erdoğan, lauded the growth figures as a reflection of what she said were, “sound government policies”.

But the reality is somewhat different. All signs point to an overheating economy, spurred on by government tax cuts and loan guarantees. Erdoğan and his advisers, who are encouraging the central bank to keep interest rates low, hope that the measures will keep economic growth thundering on until presidential and parliamentary elections, due in November next year.

The economy has entered a “rapid growth process”. Nihat Zeybekci, Erdoğan’s economy minister, said after Thursday’s figures were announced. All indications are that the government will beat a target for growth of 5.5 percent in 2018, he said.

Growth in Turkey - data also showed the economy expanding 1.8 percent quarter-on-quarter in the final three months of 2017 versus 1.2 percent in the preceding quarter - is coming at a massive cost, in terms of the lira’s depreciation, and at a huge risk for investors who have placed their money in the country.

Unsurprisingly, many investors are getting cold feet, adding to the lira’s woes.

A flash crash in Asian markets last week, reportedly prompted by stop losses placed by Japanese retail investors, saw the lira slide to 4.038 per dollar, the lowest level on record.

The currency traded at 3.95 per dollar on Thursday.

Lira futures tracked by CME Group predict that the currency, which traded at 1.15 per dollar just before the 2008 financial crisis, will decline to 4.11 by the end of June, 4.35 by December and 4.75 by September next year, just prior to scheduled elections.

June 2018 futures were at 3.98 per dollar two weeks ago. Prices for the futures are calculated by taking into account interest rate returns.

After raising interest rates for its late liquidity window by 50 basis points to 12.75 percent in December, Turkey’s central bank appears hesitant to increase rates further due to government pressure. That presents an opportunity for currency traders, according to FXWirePro.

The lira’s initial depreciation often “catches fire” later because the market wants to test the central bank’s resolve, the currency news specialist said in an analysis on Wednesday.

“This has become a standard market theme since 2013 as the central bank has typically been reluctant to raise rates,” it said. “This tends to kick-start a spiral between lira depreciation and inflation, which then results in significant foreign exchange overshooting.”

The Turkish central bank is unlikely to tighten monetary policy at levels of 4 per dollar, according to William Jackson, an emerging markets economist at Capital Economics in London.

Past experience shows that the lira would probably need to weaken to 4.25 per dollar, equating to currency depreciation of 10 percent over a three-month period, before the central bank acts, Jackson said last week, according to Bloomberg.

Goldman Sachs and UniCredit are also among financial institutions recommending that their clients sell the currency.

It may be that the Erdoğan is willing to make sacrifices in the value of the lira in exchange for maintaining his growth program.

The government plans to introduce additional incentives to boost economic growth equating to 128 billion lira ($32 billion) in project-based financing, Prime Minister Binali Yıldırım said on Wednesday. This comes on top of additional money the government is making available in loan guarantees to industrial companies that totalled more than 200 billion lira last year.

Further clues that the government is willing to let the lira slide were provided by Cemil Ertem, another adviser to Erdoğan, in comments last week. While saying that the government considered levels for the lira weaker than 3.85 per dollar as speculative in nature, Ertem said the currency was free-floating and would find its natural level.

Still, how far the government is willing to allow the lira to depreciate is another question. Declines for the currency are inflationary, meaning that spending power of Turkish consumers is eroded, and also make foreign debts for Turkish companies more difficult to repay.

Even after government measures to curb borrowing in foreign currency by Turkish firms, they still owe a net $214 billion, close to an all-time high, according to central bank data. That is more than double the levels of 2009. Turkish banks hold about 80 percent of those liabilities.

The International Monetary Fund and Moody’s Investors Service, which cut Turkish sovereign debt one level to two steps below investment grade in March, are among institutions warning about economic overheating and its impact on inflation and private debt.

Still, warnings by both institutions have fallen on deaf ears. Ertem said two weeks ago that the IMF’s policies were antiquated and Turkey would do exactly the opposite of what fund officials recommend.