May 18 2018

Lira’s slide: The political risks are mounting  

It really is hard to make sense of the course of economic policy in Turkey these days with President Recep Tayyip Erdoğan’s self-harming comments from London on interest rates creating tremors in the markets ahead of June 24 elections.

As the lira hit a shocking new record low on Thursday of 4.5 per dollar, the central bank of Turkey, from which investors expect a rate hike immediately to stop the bleeding, issued a simple two-sentence statement on its website.

“The CBRT is closely monitoring the unhealthy price formations in the markets. Necessary steps will be taken, also considering the impact of these developments on the inflation outlook.”

Its words did not help much of course.

Turkish lira versus emerging market currencies
Turkish lira (in purple) versus emerging market currencies

What did work to reverse the free fall in the lira was the summoning of Central Bank Governor Murat Cetinkaya to the headquarters of the governing Justice and Development Party (AKP) in Ankara on Wednesday for a meeting with Erdoğan, along with a number of ministers responsible for the economy. For the second time in two weeks, such discussions escalated expectations of an emergency rate hike later in the day. The lira eased back to 4.41 per dollar. But the bank has yet to hold a meeting of its Monetary Policy Committee. The market, full of wishful thinking, is still giving the central bank the benefit of the doubt that it will meet and hike interest rates in the next few days.

Just like a tornado gaining force as it moves around, each disappointment for investors returns with a stronger lira devaluation. This time around, unless the central bank follows up and delivers what is needed -- which is a 200-400 basis point rate hike, the downward spiral in the currency could get wilder and wilder.

The truth is of course that the lira’s weakening is by no means groundless in terms of economic indicators. 

Double-digit inflation looks set to stay in Turkey. Price increases, which were expected to be around 11 percent by the end of 2018, could well hit 13-15 percent given the free fall in the lira, which has reached 15 percent against the dollar since March.

The most recent balance of payments statistics, published earlier this week reveal that Turkey’s current account deficit reached 6.5 percent of GDP in the first quarter. The financing side was even scarier, with most of the funding of the deficit covered by central bank reserves and the “net errors and omissions” item, whose sources remain a mystery.

Unable to increase debt rollover ratios beyond 100 percent, Turkish banks and the private sector stand out as net external debt payers. This also hurts the financing of the ever-growing current account deficit. Even the Treasury was a net payer of debt as it refrained from borrowing on international markets because conditions were not appealing enough.  

Furthermore, developments on the fiscal side are far from encouraging. With a swathe of fiscal support measures unveiled ahead of the June 24 elections, Turkey’s budget deficit is set to grow to 2.5-3 percent of gross domestic product this year compared with last year’s 1.5 percent.      

All combined, it is of course not a mystery that the lira had been losing ground since January and previous to that. Yet, what brought the lira weakness to unprecedented levels is none other than Erdoğan himself.  So, now that the U.S. 10-year bonds are trading above yields of 3.1 percent, weary investors are fleeing Turkey’s financial markets as they fail to see a sense of economic rationality or reality in Erdoğan, who is keen to be the sole captain for every sea. 

Deputy Prime Minister Mehmet Şimşek said on Twitter this week that the government “remains committed to a sound and prudent policy framework”. But he added that the measures are set to come after the elections. This does not help much when it comes to the deterioration in sentiment towards emerging markets.

While investors are divided on the outlook for developing countries, with some expecting a recovery and others calling for more pain, one thing they agree on is that the heat on Turkey and Argentina is here to stay. 

Argentina is of course another story, but in Turkey’s case Erdoğan’s unwillingness to slow economic growth for the sake of better macroeconomic balances is the main factor that is poisoning the atmosphere. 

The problems for Turkey have deepened because when we are talking about the economy all we are mentioning is the president’s name.

The economy team seemed to have vanished this week when Erdoğan told investors in London that he would impose a tighter grip on management of the economy should he be elected president with enhanced powers on June 24.  He asserted that high interest rates hurt the competitive powers of Turkish corporates in global markets and thus should be slashed. He blamed double-digit inflation not on his policies but on double-digit interest rates. This approach is turning into a vicious circle of reasoning that feeds economic mismanagement.

Furthermore, Erdoğan’s plans to ease pressure on the lira via trading with other countries in gold and local currencies is of no help when the external short position of Turkish corporates is $227 billion, or about 30 percent of GDP.

There is more than a month until the June 24 presidential and parliamentary elections in Turkey. Such a period seems too long to wait for “a correction in the economic policy mix”, as Şimşek has proposed for after the polls, given Turkey’s economic fragilities, which are increasing day by day.