In the aftermath of the reelection of President Recep Tayyip Erdogan, the Turkish Lira (TRY) fell to record lows against the US Dollar (USD). Last Wednesday, the lira weakened by around 7% on one day alone and hit 23.18 against USD. This means TRY has now depreciated in value by about 20% since the start of the year.
It is true that almost all emerging market currencies have struggled in recent years. The turbulence of both the coronavirus pandemic and war in Ukraine prompted a flight to “safe” financial assets, particularly the US Dollar, and dampened risk appetite for emerging markets.
Higher interest rates in the United States, instigated by the Federal Reserve in a bid to tame rampant inflation, also encouraged foreign exchange traders to obtain greater exposure to the greenback to benefit from the higher yields on offer. This came at the detriment of currencies such as the lira.
However, the lira has suffered more than most because of the unorthodox policies pursued by President Erdogan and the Turkish Central Bank. Contrary to the basic laws of economics, Erdogan believes that the answer to higher inflation is to cut interest rates. He apparently views higher rates as a “scourge” that allows greedy foreign speculators to profit from the Turkish currency. Throughout his second term in power, he sacked several central bank officials who tried to argue for a change of course. Persistent inflation and ever-lower interest rates helped to send the lira tumbling.
As Erdogan begins his third term in power, there is cautious optimism that Erdogan may be prepared to reassess some of these ideas. He has appointed orthodox figures – Mehmet Sismek and Hafize Gaye Erka- to the posts of Finance Minister and Central Bank Governor. Both are former bankers, having worked at Merrill Lynch and Goldman Sachs respectively, that are well-respected by financial markets and institutions.
Simsek has said that he will return to “rational” economics and, if he can follow through on this, that should give the lira space to appreciate or at least stabilise against the dollar.
One lingering problem for lira markets is that it is difficult to trust that Erdogan will stick to orthodox policies, even when the signals are encouraging. In the past, Erdogan has appointed orthodox figures to influential posts but then dismissed them within months. Previous central bank chief Naci Agbal was sacked after just four months in office.
Economist Timothy Ash therefore believes that to build credibility, Erka needs to move quickly to hike interest rates meaningfully – to demonstrate that Turkey is fully committed to monetary orthodoxy. He told Disruption Banking that a hike of at least 1000 basis points is required if any optimism is to return to lira markets.
Ash said that the performance of the lira “really depends on the outlook for interest rates.”
“If they hike rates significantly, then they should be able to stabilise the lira around current levels,” he added.
JP Morgan and Barclays have both stated that they expect the Turkish Central Bank to lift rates to 25% at its next meeting on the 22nd June, up from the current level of 8.5%. Société Generale expects a more modest initial rise of 6.5%, but also expects rates to reach 25% by August. If these global banks are correct in their forecasts, the lira could begin to stabilise.
However, in Ash’s words, “if they disappoint with rate hikes, then things could get ugly quickly.”
Author: Harry Clynch
#Turkey #TurkishLira #Erdogan