Turkish president Recep Tayyip Erdogan’s attempt to take control of all levers of power and a mounting terrorist threat has begun to alarm investors, sending the Turkish lira down 4 per cent to an all-time low on Wednesday.
The lira traded at 3.93 to the dollar, down 12 per cent since the beginning of January, clocking its worst performance since a failed coup in July which prompted a purge that has ensnared corporates, business leaders and more than 100,000 civil servants. It shed 17 per cent of its value against the dollar in 2016.
All emerging markets have suffered since the November election of Donald Trump as US president, with investors pulling cash out in anticipation of rising global instability and rising interest rates in the developed world.
But Turkey has become one of the most fragile, because of high political risk, substantial foreign currency-denominated corporate debt and comparatively low central bank reserves to defend its currency.
A spate of terrorist attacks by Islamist and Kurdish militants, Turkey’s entanglement in Syria and plans by Mr Erdogan to concentrate power in the presidency have all rattled investors.
“We are witnessing a full-scale crisis of confidence in the lira caused by rapidly escalating market concerns about domestic factors dominated by prevailing security issues, uncertainty in politics after the failed coup and the risk of a downgrade by rating agencies,” Piotr Matys, forex EM strategist at Rabobank.
“It is complete mayhem,” said a trader who asked not to be identified, after his brokerage received an admonishment from senior Turkish officials enraged by low bids for the lira.
With dwindling reserves, analysts believe the only solution is an increase in official interest rates by the central bank. But Mr Erdogan has long denounced high interest rates as a brake on Turkish growth, occasionally depicting them as a conspiracy against the country.
He has demanded lower interest rates to jump-start an economy that has effectively stalled. It shrank 1.8 per cent in the third quarter of 2016, while consumer confidence, manufacturing and credit growth all fell as inflation soared.
Murat Cetinkaya, the central bank governor, has largely toed the president’s line, dropping the benchmark by 250 basis points, before small increases of 50 and 25 basis points to the one-week repurchase and overnight lending rates, respectively. He must now decide whether to raise rates to defend the lira at a scheduled meeting on January 24.
“The interference of the government with the central bank’s functioning is one of a kind — Mr Erdogan wants the rates to remain low for growth, so they’re caught between a rock and a hard place,” said Eirini Tsekeridou, analyst at Julius Baer, which now forecasts the lira at 4.10 to the dollar in the next three months.
Mr Erdogan’s government has blamed the currency meltdown on speculators, calling it an “economic coup”. His government called Moody’s, the rating agency, economic terrorists after it warned this week that Turkish banks’ non-performing loans could climb to 4 per cent.
The lira’s recent weakness uncouples it from its emerging market peers, especially the so-called Fragile Five (Turkey plus Indonesia, South Africa, Brazil and India) which have fared comparatively better as the US Federal Reserve prepares to increase rates. It has fallen about twice as much as the Mexican peso, which has been hit by Mr Trump’s hard line on trade.
The trigger for the latest slump was November’s current account figures that showed a $590m deterioration in the deficit, heaping further pressure on the slowing economy.
The Central Bank of Turkey on Tuesday warned currency speculators that it was monitoring excessive market volatility and would “take necessary measures against unhealthy price formations inconsistent with economic fundamentals”.
The bank boosted foreign exchange liquidity by reducing reserve requirement ratios by 50 basis points and lowered banks’ borrowing limits to TL22bn.
The CBT would need to raise rates further at its next meeting to halt the lira’s decline, said Antje Praefcke at Commerzbank.
“Increasing FX supply in the banking system is neither necessary nor sufficient to combating lira depreciation. The CBT will inevitably have to do more,” said Ms Praefcke.
Citigroup economists Ilker Domac and Gultekin Isiklar said that the adverse consequences of a declining lira on inflation and financial stability made it increasingly difficult for the CBT to maintain its accommodative stance.
“Turkey’s disappointing performance regarding price stability is becoming more of a drag on the country’s competitiveness under current global conditions,” they said.
