Turkish lira may be heading into perfect storm as defences weaken

Turkey’s lira may be heading into a perfect storm as eroding central bank reserves, a mounting pile of foreign debt and political factors combine to exert pressure on the beleaguered currency, Reuters reported.

The lira dropped to an all-time low on Thursday, reflecting declining confidence towards the major emerging market country.

At the centre of concerns is monetary policy. Urged on by the government, the central bank has used up tens of billions of dollars of its foreign exchange reserves to prevent the lira from weakening. At the same time, it has slashed interest rates to single digits and to below the annual inflation rate, making lira-denominated assets less attractive.

Using five charts to show why the pressure on the lira has now become so intense, Reuters said the coronavirus was bringing a deep economic recession and the country is also faced with huge dollar-denominated liabilities to finance this year.

Some analysts predict that the central bank’s gross reserves, which stand at about $50 billion, may be used up within months, Reuters said. Net reserves have dropped to $25 billion from $40 billion at the start of the year. Comforting words this week from Treasury and Finance Minister Berat Albayrak have failed to allay investor concerns, it said.

Turkey is also heading for a second recession in less than two years – the International Monetary Fund is predicting that the coronavirus will cause an economic contraction of 5 percent in 2020. Meanwhile, ratings agency Standard & Poor’s says this year’s tourism season will be largely lost and the budget deficit is expected to widen to 5 percent of gross domestic product (GDP).

Real yields on 10-year government bonds, when accounting for inflation, are at about 3.2 percent, among the lowest in major emerging markets, Reuters said. The decline has been sparked by a sharp reduction in interest rates, raising the question about whether investors are being adequately compensated for risk.

The slump in the lira is also making it more expensive for Turkey’s government and companies to refinance a pile of short-term foreign currency debt. The country needs to service almost $170 billion over the next 12 months, equating to 24 percent of GDP, Reuters said.

The central bank’s $85 billion of overall gross foreign currency reserves, which also includes hard currency parked by the country’s banks, covers just 50 percent of short-term debt obligations, one of the lowest levels in emerging markets.

At the same time, politics is having a negative effect on investor sentiment. In foreign relations, Turkey’s ties with the United States have been undercut by its purchase of Russian S-400 missiles. The country is also embroiled in the civil war in Syria, a dispute over natural gas rights with Cyprus and relations with the EU are strained by migration, Reuters said.

Investors had hoped that possible dollar swap lines with the U.S. Federal Reserve might help ease pressure on the lira and the wider economy. But a top Fed official said this week that such facilities were only given to countries of “mutual trust” and possessing strong credit credentials.