Last year, Turkey’s economic woes contributed to a febrile international climate that undermined investor confidence in emerging market currencies generally. While the lira’s slump at the end of last week shows the nation’s challenges persist, this time the issues are ring-fenced, making the drama a purely domestic affair. For now, at least.
There are two big differences that should prevent any new weakness in the lira from becoming contagious. The country’s runaway inflation, which peaked at 25 percent, is now back below 20 percent and its huge current account deficit has all but disappeared. Just as important, the central bank has been swift to act after Friday’s selloff.
The bank suspended daily auctions for its benchmark one-week repurchase rate (the process where it lends money to commercial banks), where the official rate is set currently at 24 percent. Instead, lenders are having to borrow at the overnight official rate of 25.5 percent – although the market rates are much, much higher than this. It’s a message from the central bank that if the lira doesn’t recover its poise, then the suspension will continue, and that will mean an effective interest rate hike. It thereby protects the currency, but at quite a cost given the magnitude of those overnight market rates.
At the same time, the central bank has temporarily halted daily foreign currency swap auctions, making it harder to sell the lira and buy overseas money. A strongly worded response from President Recep Tayyip Erdogan also helped the lira recover most of Friday’s near 7 percent decline.
The initial plunge came on the same day as a report from JPMorgan Chase & Co. analysts, which said sharply falling foreign exchange reserves would pose a risk to the lira’s value once next weekend’s municipal elections were over. Official reserves fell unexpectedly by $6.3 billion in the first two weeks of March, the steepest drop in more than five years, prompting speculation that the central bank had been propping up the currency. It denied this, attributing the decline to the servicing of foreign debt and the need to provide dollars for the state energy sector. (An explanation that had the perverse effect of highlighting two of the biggest drags on Turkey’s economy.)
Nonetheless, the authorities’ response has made it more expensive to bet against the lira. If the daily auctions don’t resume before the weekend, then commercial banks will have to switch all of their short-term funding to the more expensive overnight lending rate. This is no doubt designed to squeeze any short-sellers in the currency.
But there’s a heavy price to pay for Turkey maintaining a better grip on its external issues. Commercial banks are under pressure from the authorities to keep lending rates to corporates as low as possible, but now their short-term funding costs have entered the stratosphere. The overnight market rate has spiraled above 300 percent. Shares in Akbank T.A.S, a large Turkish lender, have fallen more than 12 percent since Friday, while the sector hasn’t done much better. There will come a point when the central bank has to ease the pain of domestic lenders.
And the the environment is hardly benign. Despite a substantial recovery from its lowest ebb last summer, the lira is still 30 percent cheaper against the dollar than it was a year ago. Meanwhile, fourth-quarter gross domestic product fell 3 percent year-on-year and the first quarter will almost certainly confirm the country is in recession. One consolation is that this has helped rein in inflation and the current account deficit: Four of the last six months have shown a current account surplus.
So long as Turkey’s focus stays on supporting the currency, its impact on international markets will be limited. For the moment, its problems are its own.
(This column has been updated to include the overnight money market rate on the Turkish lira.)
To contact the author of this story: Marcus Ashworth at firstname.lastname@example.org
To contact the editor responsible for this story: James Boxell at email@example.com
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
©2019 Bloomberg L.P.