May 29 2019

Turkish lira defence weakened as rates drop below crisis levels - IIF

Turkey’s lira and its economy lack a strong defence from interest rates, which are below the levels seen during an emerging-market sell-off last year, said economist Robin Brooks.

The interest rate differential between the lira and dollar, as implied by currency forwards, has dropped to 24.6 percent from 31.3 percent in October last year, Brooks, chief economist for the Institute of International Finance, said in comments on Twitter.

“An important way Turkey can restore foreign investor confidence ahead of the June elections, given worries over another credit expansion: a strong interest rate defence. What we're seeing is short of that,” said Brooks, who is a former chief currency strategist at Goldman Sachs.

Turkey’s central bank has kept its benchmark interest rate of 24 percent unchanged since September last year despite continuing losses for the lira.

The lira weakened 0.3 percent to 6.04 per dollar at 10:30 a.m. local time in Istanbul on Wednesday, taking a decline this year to almost 13 percent. The lira fell by 28 percent in 2018, hitting a record low of 7.2 per dollar in August, before the September rate hike helped stabilise the currency.

Turkey is holding a rerun of March 31 elections for the mayor of Istanbul on June 23. The decision to hold a new vote, taken by the election board on May 6, has unnerved investors, who say it encourages more populist economic policies by the government. Among the measures the government has taken is to increase the amount of low-cost loans offered by state-run banks.

Interest rate differentials measure the difference in interest rate returns between two currencies in a pair. If one currency provides an interest rate of 10 percent and the other a rate of 2 percent, then the differential is 8 percent.

A currency forward is a trade that locks in the exchange rate of a currency against another for a future date. The price reached includes differentials in interest rates.