Short Insight – Turkey: from fragile to failing?

by: Nora Neuteboom , Georgette Boele

  • The lira sell-off has continued in recent weeks
  • The central bank is considering to take appropriate steps
  • We expect the CBRT to hike rates soon
  • We revised our year-end USD-TRY forecast to 4.5 (from 4.2)


180518-Short-Insight-Turkey_final-4.pdf (264 KB)

1. The lira sell-off has continued in recent weeks

The lira has lost 12% versus the dollar since the beginning of April (18% since the beginning of the year). The strengthening dollar and rising US interest rates have hit the most vulnerable and risky EMs including Turkey hard. Moreover, rising oil prices further increase the inflationary and current account deficit (CAD) pressures in net-energy importers such as Turkey. There are also other Turkey-specific factors at play. The government has pushed growth towards a point where the economy shows clear signs of overheating, as inflation continues to increase (10.9% yoy in April) and the current account deficit widens further (5.6% of GDP). On top of that, in the run-up to the presidential elections which will take place June 24, the government has pursued expansionary fiscal policies. Furthermore, Turkey continues to operate in a difficult geopolitical environment. The US-Turkey relation has been strained over revolving issues around Syria, Halkbank, the imprisonment of the US pastor and Turkey’s backsliding on democratic norms.

2. CBRT is considering steps, Erdogan stays put

While inflation keeps trending higher and stands around 6%-points above the target of the Central Bank (CBRT), monetary policy remains loose. Erdogan’s latest remarks on his trip to London were not particularly promising for investors as he restated his view on how higher interest rates fuel inflation. Furthermore, he emphasised that he has significant control over monetary policy. That said, on May 16 the CBRT released a market development statement, stating that it is closely monitoring the unhealthy developments in the lira and necessary steps will be taken. The last time the CBRT posted a similar message was in January 2017, shortly before they took bold steps by increasing Overnight Lending Rate by 75pb and the Late Liquidity Lending Rate by 100bp, effectively increasing average costs of funding by 200bp.

3. We expect a rate hike on June 7

If we would take this CBRT statement at face value, it is likely that the CBRT will take a similar bold move again. Although Erdogan’s pressure on the central bank cannot be ignored, in 2014 and in 2016, the CBRT was independent enough to raise rates aggressively. Also, we should keep in mind that the falling lira is not serving Erdogan’s constituency well, as it feeds into inflation and hurts SMEs that have borrowings in foreign currency. The CBRT is well aware of the effect that an interest rate hike could have on the lira. An unscheduled meeting between Erdogan and CBRT governor Cetinkaya on May 16 fuelled market speculation on rate hikes, resulting in a temporary recovery of the lira (USD/TRY down by 2%). In order to stop the freefall in the lira and to save the credibility of the CBRT, much depends on the upcoming monetary policy meeting. We expect the CBRT to take action. In our base scenario we assume the CBRT will increase the Late Liquidity Lending Rate by 150bp and the Overnight Lending Rate by 25bp at the regular policy meeting on June 7. However, if the lira sell-off continues in the same pace as last weeks, we do not exclude an earlier emergency meeting either.

4. Downgrade of our lira forecast

The lira is currently at an all-time low versus the US dollar and it behind the Argentina peso the worst performing emerging market currency this year. We expect the lira sell-off to continue until the CBRT meeting. If the central bank hikes interest rates as we expect, this should provide support to the lira in the near term. The lira could recover to 4.1-4.2 versus the US dollar. However, if after the elections Erdogan continues to ventilate his views that the CBRT is not independent and interest rates will not rise, it is likely that investors will again sell the lira aggressively. Later in the year we expect the US Treasury yields and the US dollar to peak. This should result in less upward pressure in USD/TRY. To take all this into account, we have downgraded our lira forecasts. Our new year-end USD /TRY forecast is 4.5 (previously 4.2).