Analysts saw Turkey entering into a balance of payments crisis as the markets on August 9 seemingly gave a big thumbs down to a preview of the government’s planned new economic model and the free fall of the Turkish lira (TRY) sent it crashing through the 5.50 to the dollar threshold - the scenario significantly worsened on the morning of August 10 when the TRY breached the 6.0 level.
One factor behind the latest sharp descent, of more than 10% d/d, may have been a Financial Times report that the eurozone’s chief financial watchdog is concerned the zone’s major lenders are overexposed to Turkey.
On August 9, the TRY got as far as 5.5630 during the day—before August 10, that was its latest all-time low in a year where it has so far now lost more than a third of its value against the dollar—with news that a Turkish delegation sent to Washington to address Ankara’s deepened rift with the US was not making any apparent progress piling on the agony.
Market observers continued the debate over whether Turkey was now at the point where it needed to go cap in hand to the International Monetary Fund (IMF) or bring in capital controls. Others said President Recep Tayyip Erdogan, who appears to have taken control of monetary policy as part of his new executive presidency, urgently needed to give the central bank the nod for a substantial round of tightening. Doing so would require some swallowing of pride for Erdogan, who continues to push his unorthodox brand of economics under which—according to his theory that interest rates are the “mother and father of all evil”—Turkey, despite its runaway double-digit inflation, headache-inducing current account deficit, collapsed lira and patently overheating economy still needs cheaper credit to fuel growth.
Cristian Maggio, head of emerging market strategy at TD Securities in London, got straight to the point in remarks reported by Bloomberg. “We are entering into a balance-of-payment crisis here. It won’t stop unless the central bank steps in and hikes big time."
As pointed out by Capital Economics in an August 8 note to investors, the fear that Turkey could be on the way to a “full-blown crisis” can be attributed to the sheer scale of its credit boom. Turkey’s private sector credit-to-GDP ratio has risen by 45 percentage points over the past 15 years from below 20% after the 2001 crisis to above 60% since last year.
Rout upon rout
By 00:15 Istanbul time on August 10, there was no sign the latest market rout was over, with the TRY standing at 5.5558. The currency during August 9 only briefly managed to pare back some losses after the government set a growth target of less than 4%, down from 5.5% and said the recently appointed treasury and finance minister, Erdogan’s son-in-law, Berat Albayrak, would be unveiling a Treasury road map on how it is going to address the economic ills besetting Turkey’s $880bn economy on August 10 at 11:00 local time.
However, the lira quickly began its nosedive again as, in the view of Timothy Ash at BlueBay Asset Management in London, the markets sent the message of “sort out the relationship with the US first, then come and talk with us”. He added: “And I guess the market is also saying, we want to see a credible reform team, and fast… [It is saying] why should we trust the new economic team, which is unproven. And with the [central bank’s] credibility shot to hell, we need to see people that are tried and tested in key positions which we trust to deliver. The recent experience with the existing team has not been great.”
Ash continued: “It’s a case of seeing is believing in terms of delivery. Albayrak needs to be specific in terms of how exactly he is going to cut the budget deficit this year. It’s great having nice targets, but let’s not forget the Turkish central bank has a 5 percent inflation target and has not met it over the past decade.”
Turkey’s benchmark one-week repo rate currently stands at 17.75%. Maggio reportedly said it needs to rise to 30% to stem the lira’s rout, if not in one move, then in as many as four smaller increases.
Apart from the adjustment in the government’s GDP target, Albayrak is also set to explain at his briefing how less government borrowing will mean the domestic debt rollover ratio will be 104% at the end of 2018, down from an earlier forecast of 110%.
Other points he is set to address are how lower spending and increased revenue will deliver around TRY35bn ($6.5bn) for the government across the rest of the year, helping the budget to run a surplus of around TRY5bn, excluding payments on interest; the budget gap will be less than 2% of economic output this year, in line with previous estimates, and will be capped at 1.5% of GDP in the medium term; the ratio of the current account deficit to GDP will stabilise at 4% during the same period and inflation will be lowered to single-digit levels as soon as possible.
Albayrak is also set to detail why in his view Turkey’s banks and non-financial companies face no foreign exchange or liquidity risk.