The Turkish lira on December 14 tested over 5.40 to the USD after economic growth indicators for China and Europe triggered a sell-off in emerging markets assets.
Emerging market stocks were set for their second consecutive week of losses amid worries about a slowdown in China’s growth coupled with weak European PMI readings, while currencies weakened after four weeks of gains.
The Turkish lira (TRY) saw as high as 5.42 for the first time since mid-November while it was trading at 5.3845, weaker by 0.80% d/d, as of 18:25 local time.
By mid-afternoon trading, the Istanbul stock exchange’s benchmark BIST-100 index was down 1.59% d/d at 89,930, bringing the annual loss to 22%. At the end of September, the index saw levels over 100,000.
Borsa Istanbul began this year with a bounce, with the BIST-100 climbing to its all-time high of 120,845 through the end of January. However, as Turkey’s currency crisis and other economic woes mounted, the index gradually fell to as low as 84,654 by August 17.
Fitch Ratings is expected to release its regular rating decision for Turkey late on December 14 after the market close.
“I cannot see them moving their BB rating. They only downgraded back in July, from BB+. That said, Fitch's rating is one notch higher than Moody’s’, and now two above S&P. But for me, [it will be] wait-and-see from Fitch most likely, and especially given the policy response on-going, of hiking rates/keeping rates high, plus the re-balancing we are seeing on the current account, plus still the strong public finance profile. The banking sector is still proving resilient,” Timothy Ash of Bluebay Asset Management said in an emailed comment to investors.
“Likely to remain deep in recession”
“While we warned about vulnerabilities in Turkey and Argentina, we hadn’t anticipated that they would both suffer currency crises [in 2018],” Capital Economics said on December 13 in a Key Calls for EMs in 2019 note, adding: “[W]ith growth in China, the US and the eurozone weakening, export demand is likely to soften. Turkey and Argentina are likely to remain deep in recession [in 2019] as they continue to suffer from the fallout from their currency crises.”
“We argued (correctly) during the middle of this year that Turkey and Argentina’s currency crises would be isolated cases—their balance sheets were simply much weaker than those of other large EMs. And it now looks like these two economies are undergoing sharp adjustments in their balance of payments, which should help to limit the risk of further large currency falls,” the economic research company also said.
In a research note on Turkey’s Q3 GDP data release, Renaissance Capital said on December 13: “We still think consensus and the IMF have to revise down their over-optimistic view on Turkey’s economy in 2018. Bloomberg consensus STILL has GDP rising 3.5% in 2018 and then slowing to 0.6% in 2019… The IMF in October forecast Turkey slowing to 3.5% in 2018 and 0.4% in 2019. Our numbers now have Turkey’s GDP slowing to 1.3% in 2018 and 0.8% in 2019. This is important because markets try and price in growth a year ahead, and accelerating vs decelerating growth matters. If the IMF and Bloomberg consensuses are right, you should not touch Turkey with a bargepole—given the massive slowdown which they think will be as big as the hit that Argentina and Turkey received in 2018 (vs 2017). We think Turkey will slow—but similar to China and Chile—and that implies there may be decent stories to find in the market.”
Some upside risk
Renaissance added: “There is some upside risk to our view now. The currency has come back to the 5.2-6.0/$ target range that we flagged in August and September when the currency was weaker than 7/$. Inflation has dropped to 21.6% thanks to this recovery. This means that our estimate of Turkey’s fair value in 2019 is looking 3-4% better than a month ago, so the currency looks cheaper on a forward looking basis (if YoY inflation was 25%, we might expect fair value for the TRY to move from 3.75/$ in May 2018 to 4.7/$ by May 2019 but at 22% inflation, it might only rise to 4.55/$--so investors get more for their money buying the TRY now).
“A somewhat stronger currency in mid-2019 would be consistent with faster than expected rate cuts. Falling oil prices obviously helps Turkey too. On the negative side, the global economy looks weaker than it did a few months ago, but as that implies less Fed hikes, this too has some benefit for Turkey. So we see upside risk to our 2019 GDP forecast, which is already higher than Bloomberg consensus and the IMF view. The random variable in all this is President [Recep Tayyip] Erdogan. We can’t rule out the chance that he will snatch a bigger recession from the jaws of a relative mild recession, by interfering in monetary policy again.”
The negative impact of lira depreciation on the Turkish economy will last for 6-7 months until the spread between the producer and consumer price inflation figures closes, Japan Credit Rating (JCR) Eurasia Rating head Orhan Okmen said on December 14 in a written statement.
Rebalancing in external vulnerabilities
Okmen added that falling FX demand has already initiated a rebalancing period in Turkey’s external vulnerabilities but the March 31, 2019 local elections weight on the budget and the direction of international relations would determine how permanent rebalancing would turn out to be.
He also stressed that rebalancing would not be secured until loan growth recovered, noting the banking industry’s reluctance to provide fresh loans obstructs growth, fuels corporate bankruptcies and deepens contraction in domestic demand.
With the aim of reviving loan growth through “natural ways”, revising risk weights on assets based on developed countries’ standards would create additional loan capacity equal to almost half of the current commercial loans volume, according to Okmen.
Okmen also said that a possible revival of quantitative easing in developed countries brought about by a slowdown in economic activity would also help Turkey in 2019.