Rebalancing needed in the economy
The current account (CA) deficit hit a high of $51bn in January and TRY appreciated in real terms 23% since last year. Bank loan growth have been accelerating following the rate cuts in fall. Minimum wage increased 99% over last year while CPI inflation was 65%. Early retirement measure and earthquake related spending will weigh on the fiscal balance. Usable FX reserves of the CBT decreased from a peak of $42.6bn mid-December to $25.1bn in March. All indicators point to a need to rebalance the economy.
We believe that tightening in financial conditions, substantial cuts to non-earthquake spending and a depreciation of 15-25% in TRY are necessary to achieve it.
Elections May 14
The election date has officially been set for May 14. The opposition coalition Table of Six (To6) announced CHP leader Kemal Kilicdaroglu as their common candidate and pledged a return to orthodox policy if they win. If the current leadership wins, we expect the existing policy framework to be maintained. Regardless of the outcome, we see a weaker TRY and tightening economic conditions to address imbalances in the economy.
Brace for volatility
Under orthodoxy, the authorities would ease regulations, which would increase volatility but also liquidity in the TRY-based asset markets. An opposition win is likely to cause volatility right away until the economic posts are filled, and a new economic policy framework is announced. We see the policy rate at 30% initially before rising gradually to 50% by the end of 3Q, and 45% at year-end. Any excessive capital inflows would likely be purchased by the CBT to build up reserves. We believe nominal appreciation of the currency would not be allowed as this would destabilize the economy.
Strategy: weaker TRY, higher liquidity, support for basis
Our Compass model, which backs out fair values from a comparison of actual current account balances with their long-term norms, shows USDTRY’s fair value is about 24.
This suggests USDTRY could go even higher, as exchange rates often overshoot their fair values. We prefer to express our FX view through forwards (rather than options) as downside in USDTRY is limited due to the lira’s overvaluation. If orthodox policies are adopted and the policy rate goes to 50%, we see the 10y bond yield peaking at 29-30%, overshooting our fair value estimate of 28%. On the sovereign side, we see support for buying the basis. If incumbent wins, we expect CDS not to widen aggressively. If the opposition wins, sovereign bonds still have room for further rally although most of the rally to close the underweight is already done. We would expect some upgrades and the bonds to be rated BB which would mean 10Y spreads at 450-475bp.
Excerpt from the same titled 14 page report
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