Turkish lira slides to record low on concerns for financial stability

Turkey’s lira dived to a record low against the dollar as investors sold their holdings on concern that a currency crisis in 2018 might be repeated.

The lira fell to as low as 7.277 per dollar in afternoon trading in Istanbul, extending losses since the start of the week to almost 5 percent. It traded down 3 percent at 7.25 per dollar as of 1:10 p.m. local time.

The Turkish central bank has slashed interest rates to below the annual rate of inflation, in line with government orders, forcing it to sell tens of billions of dollars of its foreign currency reserves to protect the lira’s value. That policy is not sustainable, economists say, pointing to the bank’s depleted reserves and a borrowing boom initiated by the government.

Yields on Turkey’s benchmark 10-year lira bond jumped 80 basis points to 14.22 percent on Thursday. That compared with yields of 11.9 percent 10 days ago. The central bank has set its benchmark interest rate at 8.25 percent and annual consumer price inflation is 11.8 percent.

Economists say the central bank should raise interest rates to defend the lira. But the bank's hands are tied by politics. Turkish President Recep Tayyip Erdoğan says higher interest rates are inflationary - a view that contradicts conventional economic theory. He sacked and replaced the central bank's governor last year for failing to support the government's pro-economic growth policies.

The International Monetary Fund warned this week that there appeared to be strong downward pressure on the lira, calling on the central bank to bolster its foreign exchange reserves in the medium term and to contain rapid credit growth. The surge in lending, led by state-run banks, is hurting the lira because it is fuelling demand for imports among consumers and businesses, widening the country’s current account deficit. Turkey needs hard currency to finance that gap.

The latest bout of lira selling came as the cost of borrowing for investors in the offshore overnight swap market surged into the hundreds of percent this week, prompting analysts to declare that Turkey’s money markets were becoming increasingly dysfunctional.

State-run banks spent more than $1 billion defending the lira on Wednesday, but the currency still fell 2 percent against the dollar.

The lira had hit an all-time low of 7.269 per dollar in mid-May, exceeding record lows reached in July 2018 at the height of the currency crisis. The losses in May prompted the Turkish authorities to strike a $10 billion currency swaps deal with Qatar to help steady the lira, rather than raise interest rates.

There was serious selling in Turkish stocks and bonds this week as foreign investors worked to meet their lira liabilities, said Enver Erkan, an economist at Tera Securities in Istanbul, according to the Financial Times. Foreigners sold a record $893 million of Turkish stocks in July, Dünya newspaper reported on Thursday citing official data.

(Story was updated wih lira record low in second paragraph, bond prices in fourth.)