The Turkish lira declined for a seventh straight day on Wednesday, bringing its losses to more than 5% since Russia launched its attack on Ukraine, raising inflation and current account risks for Turkey. It traded down to 14.67-68 in mid-afternoon, with no news of intervention by the Central Bank of Turkey (CBRT). Analysts estimate CBRT’s “usable” (easily encashable) FX Reserves are down to $40 bn at the very best. One of Turkey’s leading economists, Mr Mahfi Egilmez estimated in his 8 March blog that the Ukraine War can cost Turkey up to $30 bn, in terms of a broader current account deficit and the payments to be made by the Treasury and CBRT holders of “FX protected TL deposit scheme”. Is TL on the verge of another crash?
The TL vs USD is now at its weakest since Dec. 20, when the government announced a plan to protect lira deposits against currency depreciation, “FX protected TL deposit scheme”.
In the first two months of the year, authorities were able to hold the lira in a tight band through costly interventions in the foreign exchange market and the lira protection scheme.
The currency blew through 14 against the dollar when volatility returned in late February as the tensions between Moscow and Kyiv rose, before rebounding.
The lira is now down some 10% since the end of 2021, a year in which it shed 44% of its value against the dollar.
The currency crisis was sparked by a central bank easing cycle, that saw the policy rate reduced 500 basis points to 14% since September.
Under the lira protection scheme, the Treasury makes up for the difference between the interest rate on lira deposits and the currency’s depreciation on the maturity date.
Enver Erkan, chief economist at Tera Brokers, said the lira’s depreciation is already putting pressure on public finances as the currency’s depreciation is higher than periodic yields, and the lira deposit scheme was becoming less sustainable, Reuters reported.
“The burden on public finances means more indirect taxes or monetary expansion, which could lead to an inflationary spiral,” he said.
“The lira weakened as much as 1% to 14.6546/USD, extending its year-to-date losses to 9%, the worst among emerging-market peers after Russia’s ruble and Poland’s zloty. The dollar-lira 14-day RSI rose above 70 for the first time in almost three months, signaling to some analysts that the greenback is overbought”, added Bloomberg. “The worsening outlook is complicating Erdogan’s electoral considerations with less than 14 months left before the general elections and his popularity hovering around 40%, the lowest since his rule began two decades ago. The Turkish leader forced the central bank to lower interest rates to create more jobs but soaring energy costs are pushing Turkey deeper into a wage-price spiral”.
The interest rate cuts were part of President Tayyip Erdogan’s new economic plan that aims to turn Turkey’s chronic current account deficits to a surplus, raise growth, employment and exports while keeping low rates.
But the rise in commodity prices from oil to wheat due to Russia’s invasion of Ukraine are likely to lead to a larger deficit, while also further stoking inflation – already at 54%.
Fed Interest Rate Hikes Will Hurt Turkish Economy (And Other Emerging Markets) Badly
Tera’s Erkan said if there is a slowdown in the European industry due to the energy crisis, Turkey’s exports could also decline, risking a wider current account deficit.
Economists have said a rate hike is not in the cards, given Erdogan’s aversion to high borrowing costs.
“I think there should be a change in (the central bank’s) strategy given that keeping rates stable now is remaining behind the curve,” Erkan said, noting there has been no signal from authorities of a return to orthodox policies.
TURKEY: Next Stop Is Currency Controls
U.K based strategist for BlueBay Asset Management, Tim Ash commented in a email note: “Turkey is one of the largest losers from the war in Ukraine, thru higher energy prices – oil at $200 a barrel could be catastrophic, pushing the current account deficit to $50bn plus.
Tourism is also likely to take a hit, and higher food import prices will also impact them.
Solutions? Well the CBRT does not really have enough reserves to defend the lira for long, so they will have to allow the currency to weaken further, or hike rates, or “call a friend”. This could either be Gulf states which I guess are going to flush with oil revenues at oil at $200 a barrel or the West – Turkey is now a critical NATO ally supplying Bayraktor drones to Ukraine. I did speak at the House of Commons Foreign Affairs Select Committee on the Ukraine crisis and sanctions yesterday and highlighted that NATO ally, Turkey, will be badly impacted and should benefit from some support from the West.
That said, the obvious solution is higher rates, and with the lira again on a weakening trend, it is hard to see inflation going much lower than 50% this year, and likely will continue to head higher in the near term – 60%?”
So far “Turkey’s friends” were generous with local currency swaps, but not with hard cash to bail CBRT out. If calls are not answered, Erdogan has another option to defend the exchange rates: Currency controls.
These have a massive political cost: He may lose 2023 presidential elections. But, In the last currency crash in December, dollar/TL peaked at around 18.00, stoking the current inflationary tsunami.
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