In what was yet another torrid day for Turkey’s markets, the Turkish lira (TRY) crashed 1.8% d/d to 4.2902 against the dollar as investors continued to dump the currency despite the all-time low of 4.2487 recorded on May 3. By 18:10 Istanbul time, it stood at 4.2490. Something towards a perfect storm of domestic and international economic negatives combined to take a heavy toll, also sending government bonds to unprecedented lows.
The yield on 10-year notes climbed 38 basis points to 13.83%, the highest among major emerging markets. The cost of insuring exposure to Turkish debt, meanwhile, climbed to its highest point in more than a year, with Turkey’s five-year credit default swaps (CDS) up 11 basis points (bp) from May 3’s close to 235bp. The main BIST-100 share index was down 0.26% to 102,642.30 points by 18:15 local time.
Analysts chewed over a long list of reasons for the TRY’s sharp nosedive, including the global appreciation of the dollar with the 10-year US Treasury yield breaking above the psychologically important level of 3%; S&P’s surprise move on May 1 to cut Turkey further into junk on the growing risk of its overheating economy experiencing a hard landing; sticky and rising double-digit inflation that on April 25 was only addressed with a modest interest rate hike; higher oil prices that have pushed up the ballooning current account deficit; the upcoming parliamentary and presidential elections, the outcome of which has become less predictable; pre-election fiscal expansionary policies; latest PMI data on manufacturing pointing to contraction and signs of corporate debt difficulties that could leave the country’s banks exposed to burdensome problem loans.
Deteriorating inflation expectations, the S&P downgrade and the appreciating dollar were assessed by many analysts as the main drivers behind the TRY’s woes, while there has long been concern that the central bank is encumbered by political pressure from the unorthodox ‘Erdonomics’ of President Recep Tayyip Erdogan who regularly calls for cheaper money to drive investment and growth despite strong market pressure for tightening.
The opposition accuse Erdogan of being well aware that Turkey’s economy is coming off the rails and of having called “emergency” elections to try and secure re-election before the electorate realise just how rough an economic ride they are in for. So the question remains: if there is no let-up in the plunge of the TRY, might the country see a pre-election “emergency” rate hike?
“I do not think the central bank can wait until its June meeting in terms of a rate hike and [its planned] simplifying [of monetary policy] with funding through a single rate [instead of its present four rates] after the much higher than expected core inflation data,” BNP Paribas/TEB Investment strategist Isik Okte told Reuters on May 4.
The last meeting of the central bank’s monetary policy committee (MPC), on April 25, positively surprised the markets with a 75bp hike in the late liquidity window rate, beating the consensus that a 50bp increase was on the way. But within hours of the hike, initial strengthening of the TRY on the news was trampled by the return of the lira bears. The message from the markets that the central bankers are behind the curve is all too clear.
The next MPC meeting is scheduled for June 7, with the one after that pencilled in for July 24. The first round of the presidential election will take place on June 24. If a run-off is required, that will be held on July 8.
Hooked on hot foreign capital
Turkey’s current account deficit, at more than 5% of output, leaves the lira hooked on hot foreign capital inflows.
While the central bank has hiked borrowing costs by more than 500bp since the beginning of 2017, looser fiscal policy and a government-backed credit-fuelled economy—which last year grew at 7.4%, outstripping China’s growth—have dissolved much of the delivered benefit.
“Monetary policy stands out as the only tool to manage demand, restore credibility and hence anchor expectations,” Yarkin Cebeci, an economist at JPMorgan Chase & Co, told Bloomberg. The central bank’s rate increase last week “was not enough to restore the confidence in the bank or the lira,” he said, adding policy makers need to “act earlier rather than later.”
One positive for Turkey amid the seemingly endless bad economic news is that its local-currency bonds are not particularly popular with foreign investors. Non-residents’ holdings of the country’s bonds averaged 21.6% in the first quarter, according to central bank data cited by Bloomberg. That’s slightly below the emerging-market average of 22%. Countries with the highest foreign ownership are the most vulnerable to a selloff as US interest rates rise and trigger investors into moving money out of riskier markets and into the developed world.
The turmoil in Syria and imposition of stronger US sanctions on Moscow are, meanwhile, causing investors to turn away from increasingly risky Turkey and Russia for safer bets in Central and Eastern Europe.