Turkey is battling a political showdown and a bonds slowdown that are undermining the Turkish lira.
On the political side, Turkish PM Binali Yildirim is due in the US between November 7 and 11 where he will meet American Vice President Mike Pence on November 8 to deal with the diplomatic row caused by the arrest of a US embassy worker in Ankara and numerous other matters of dispute between their two countries that are fraying relations. On the economic side, foreign buying of Turkish local-currency government bonds has slowed to a trickle amid surging inflation, a supply glut and the tension with Washington. Against this backdrop, the lira has weakened almost 8% against the dollar in the past month. It stood at Turkish lira (TRY) 3.86/USD by around 1245 Istanbul time on October 7.
Turkey is dependent on portfolio inflows to help finance its current account deficit, which the International Monetary Fund forecasts will expand to 4.6% of GDP this year, from 3.8% last year. Thus solving the standoff with the US would be a timely boost right now.
The US and Turkey in early October mutually froze the processing of non-immigrant visas for each other’s citizens, with the Americans acting first in response to the arrest of the embassy staff member, a Turkish national, over alleged links to US-based self-exiled cleric Fethullah Gulen, blamed by the government for the failed coup of last year, and on charges of espionage.
Ahead of Yildirim’s departure for Washington, the US resumed processing non-immigrant visas in Turkey on “a limited basis” after receiving what it described as assurances about local staff. Turkey’s Washington embassy responded in kind immediately by declaring that it would too resume processing visa applications of US citizens on “a limited basis.”
The US embassy in Ankara said on November 6 that: “We have received initial high-level assurances from the Government of Turkey that there are no additional local employees of our Mission in Turkey under investigation.” It added: “We have also received initial assurances from the Government of Turkey that our local staff will not be detained or arrested for performing their official duties. Based on these preliminary assurances, we believe the security posture has improved sufficiently to allow for the resumption of the limited visa services in Turkey.”
Turkey, however, denied that it has given any assurances.
The Turkish government has an annualised current account deficit of $40bn, 70%-funded through net portfolio inflows. “Turkey needs to keep this [inflows] figure in significantly positive territory,” said Timothy Ash, a senior sovereign strategist at BlueBay Asset Management. “It needs to keep these inflows at an annualised level of USD25bn+, just to stand still, or find alternative sources of financing, and/or hike rates or allow the FX to adjust to close the external financing gap. If portfolio flows turn negative, a difficult task becomes herculean, as you then have a USS40bn CAD, plus whatever the portfolio outflows you need to cover as well.”
Turkey’s central bank on November 6 announced measures to support the weakened lira against the dollar. The upper limit and the tranches for the FX maintenance facility within the reserve options mechanism have been revised.
“The upper limit for the FX maintenance facility was lowered to 55% from 60% and all tranches have been reduced by 5 points,” it added.
The move would withdraw TRY5.3bn of liquidity from the market and provide banks with approximately $1.4bn of liquidity, according to the bank. “In the recent period, the markets have witnessed unsound price formations that are inconsistent with economic fundamentals,” the national lender said.
Ash responded to the central bank move with a note stating: “Bit of a strange statement, that the CBRT [Central Bank of the Republic of Turkey] is watching ‘unsound price formations that are inconsistent with economic fundamentals’.
Sorry, totally not the case. Inflation is more than twice the CBRT target—11.9% versus 5%—the current account deficit large and widening, and the quality of financing is deteriorating, while Turkey is engaged in major political battles with its key allies who also happen to be its main funders, and yet the CBRT refuses to do the obvious, orthodox thing and hike interest rates. As usual, the CBRT refuses to accept the obvious and instead plays around the edges with unorthodox solutions to a pretty orthodox problem—the economy is overheating after being over-stimulated.”