Mar 13 2018

Turkish lira drops to 3-month low on election fears

The Turkish lira fell to a three-month low against the dollar and posted another record low against the euro after the passage of an amendment to election laws through parliament raised the possibility of early elections.

The legislative changes, which increase government control over elections and hence the prospect of fraud, were passed early on Tuesday and add to the risks surrounding Turkey after the current account deficit more than doubled in January and Turkish troops closed in on Afrin city in northern Syria, raising the prospect of heavy military and civilian casualties.

The lira dropped 0.7 percent to 3.872 per dollar, its lowest level since mid-December. The currency fell to as low as 4.776 per euro, a new record after a previous decline last week. Ten-year bond yields rose to 12.75 percent, the highest since November.

Goldman Sachs and UniCredit are among investors recommending selling the lira, warning of overheating in the economy as President Recep Tayyip Erdoğan stimulates growth ahead of possible early elections. Presidential and parliamentary elections are due to be held by November 2019.

Turkey’s military said on Wednesday that it had surrounded Kurdish militants based in the city of Afrin in northern Syria after a campaign that started on Jan. 20 picked up speed. The United States and European Union says the incursion compromises the fight against Islamic State (ISIS) – Kurdish militants are a key element of the U.S.-backed military force – and risks a humanitarian disaster. An estimated 1 million people are holed up in the city.

Afrin
Turkish military on patrol in Afrin

Meanwhile, the nation’s current account deficit widened to $7.1 billion in January from $2.7 billion a year earlier as imports surged 39 percent, the central bank said in a statement on Monday. The rolling 12-month deficit rose to $51.6 billion, or about 5.6 percent of economic output, the highest in major emerging markets.

Turkey is financing its growing current account gap via short-term portfolio inflows as foreign investment in the country declines. A sudden outflow of the short-term money, which may be sparked by more political tensions or interest hikes by the U.S. Federal Reserve later this year, could lead to a sudden reversal in economic growth and impact the lira, economists say.

The foreign direct investment that Turkey has used to finance the deficit is in decline. Erdogan’s relations with the European Union and United States have deteriorated after he widened a crackdown on dissent following a military coup in July 2016, curtailing the inflow of money that Turkey has used to fund its economic expansion.

Investors were reminded of further evidence of the crackdown on Tuesday as a Turkish prosecutor requested that U.S. pastor Andrew Brunson serve life in jail on terrorism charges and for his alleged role in the coup. Brunson’s internment for the past 18 months has increased political tensions with the United States, prompting some senators to call for economic sanctions against Turkey.

Moody’s downgraded the nation’s debt to two steps below investment grade last week, warning that Erdogan’s increasing powers mean economic policy is becoming less predictable and compromising the central bank’s monetary policy. The bank refrained from increasing interest rates earlier this month as Erdogan’s government called for lower rates to boost growth.

Turkish five-year credit default swaps also widened two basis points to 171 bps.