As anxiety built over the dizzying descent of the Turkish lira (TRY), Capital Economics said on April 11 that it was pencilling in a 100bp hike it predicts will be introduced in the Turkish central bank’s late liquidity lending rate at the April 25 meeting of its monetary policy committee (MPC).
Various analysts have in recent weeks questioned whether the monetary independence of the Central Bank of the Republic of Turkey (CBRT) has been compromised by unorthodox ‘Erdonomics’ amid ‘warp-speed’ growth stimulated by government support for credit and investment. Populist President Recep Tayyip Erdogan has lately made a series of combative declarations that despite the TRY’s devaluation, sticky double-digit inflation and other imbalances besetting the Turkish economy, interest rates should be lowered rather than raised. But Capital Economics’ senior emerging markets economist William Jackson has concluded that even amid the forceful rhetoric, the regulator can be expected to go ahead and tighten the late liquidity rate to 13.75%.
Jackson said in a note: “Mounting concerns about Turkey’s current account deficit as well as debt problems in the corporate sector are likely to keep the lira under pressure over the coming weeks. As a result, we now expect the central bank to respond by tightening monetary policy… In an Update sent [on April 5], we argued that the lira—which at that point had depreciated to 4.04/$—needed to fall further, to around 4.25/$, to trigger a response from the central bank. Since then, the lira has continued to tumble and, at 4.15/$ at the time of writing, has already covered half the ground we suggested was needed to prompt a reaction from the central bank.”
April 11 saw the TRY sink to yet another all-time low—a rate of 4.1944 to the dollar—partly on Turkey’s building economic worries and partly on precarious international tensions, including the increasingly fraught situation developing between Russia and the Trump White House over the claimed poison gas attack in conflict-torn Syria.
The release of slightly better than expected current account deficit figures for February made little impact on the weakening of the currency. However, after some reassurances to the market from Prime Minister Binali Yildirim that the central bank remained ready to do what is “necessary”, the TRY trimmed its losses on the day. By around 0015 local time on April 12, one dollar bought TRY4.1377.
Erdogan warns economic ‘enemies’
The day also produced another foray from Erdogan against unidentified conspiratorial parties whom he alleges are attacking his country’s economy. Warning that they will not succeed, the president said in a speech in Ankara: “There are games being played with our economy... We have thwarted them and will continue to thwart them. I call out to those attacking our economy: You will not succeed.”
Bloomberg Markets on April 11 wrote that “shorting the Turkish lira is becoming one of the easiest trades in town. The wager is simple: the central bank is going to hesitate to defend the currency by raising interest rates given President Recep Tayyip Erdogan’s explicit criticism of high borrowing costs. And that’s allowing hedge funds and other speculators to pile up one-sided bets against the lira as it extends one of the biggest declines in emerging markets this year, hitting record lows against both the dollar and euro”.
“Admittedly, the government is starting to exert pressure on the central bank not to raise interest rates,” Jackson continued in his note to investors. “The authorities seem to have shifted their focus to maintaining strong rates of growth in the economy. And earlier this week, President Erdogan talked of the need to lower interest rates to boost investment. Nonetheless, this isn’t necessarily a barrier to rate hikes. Indeed, policymakers at the central bank faced similar pressures before they raised interest rates in early 2014 and again in early 2017.”
Those policymakers were likely to be concerned by the stubborn double-digit inflation, recorded at 10.2% in March, the recent sharp rise in inflation expectations, with market-based measures having hit record highs (Capital’s 5-year ahead/5-year forward break-even inflation expectations index stands at 10%), and the impact of lira weakness on the high levels of foreign currency debt in the private sector, he added. Jackson also observed that “if the MPC doesn’t tighten policy, history suggests that the fall in the lira will gather pace in the immediate aftermath of the decision, which could force policymakers to hold an emergency meeting to raise rates”.
The economist identified compelling reasons to think that the TRY will remain under pressure over the coming weeks. “To start with, the current account deficit has continued to widen—data published this morning showed that, on a 12-month rolling basis, the shortfall increased to 6.5% of GDP (having stood at just 3.5% of GDP as recently as mid-2016). What’s more, investors’ concerns about debt problems in Turkey have started to materialise and put pressure on the lira. Reports that Dogus group, a major conglomerate, became the latest company to seek to restructure debts contributed to the fall in the currency and stock market yesterday.”
Capital Economics has long warned of the risk of a rise in bad loans resulting from Turkey’s credit boom. “While Turkey’s banking sector is well capitalised and the non-performing loan ratio is currently low, these problems are unlikely to disappear any time soon,” Jackson concluded.