Turkey: Lira plummets as Turkey embarks on path of economic orthodoxy
On 30 June, the TRY traded at an all-time low of 26.1 per USD, which marked a staggering 21.8% month-on-month depreciation. Additionally, on the same day, the currency had depreciated by 36.0% in annual terms and 28.2% since the start of the year.
The TRY has been on a downward spiral over the past year, as the Central Bank of the Republic of Turkey (CBRT) lowered interest rates in a bid to support economic activity, while inflation soared and other central banks around the world were hiking. However, Central Bank intervention in FX markets softened some of the pressure on the lira.
The lira’s weakening continued after Erdogan was reelected on 28 May and maintained a dovish rhetoric. However, he made market-friendly appointments in June: Mehmet Simsek as Minister of Finance and Hafize Gaye Erkan as Central Bank governor. Under their guidance, the country has started its return to orthodox economic policy.
From early June, the CBRT reduced its interventions in FX markets amid all-time low levels of forex reserves. Consequently, the lira started to depreciate at a faster pace. On 22 June, the CBRT increased interest rates for the first time in over two years to tackle elevated inflation. That said, the hike disappointed markets on the downside, and the lira’s losses extended. Later, on 25 June, the Central Bank eased its liraization policy—which aims to ensure the prevalence of the lira in the Turkish financial system via banking regulations. In particular, the CBRT lowered collateral requirements on non-lira deposits in the banking sector, with the aim of enhancing the performance of market mechanisms and strengthening financial stability. This change added further downward pressure on the currency.
Going forward, the strength of the lira will depend on the course and pace of policy reforms. On the one hand, a further relaxation in FX interventions and banking sector regulations will likely cause further depreciation of the currency. On the other hand, higher interest rates should support its appreciation. The balance between these two opposing forces—as well as investor confidence in the currency and in Turkey’s policy transition—will determine the path of the lira. Currently, our panelists see the TRY ending the year around current levels.
Analysts at Fitch Solutions commented on the Bank’s regulatory approach:
“We would be surprised to see an extensive removal of macroprudential policies from the Bank, which would surely trigger big outflows [of] the lira. […] Premature removal of further liraization policies (ie before economic stability is regained in a higher rate environment) would facilitate further lira outflows. Indeed, the Bank seems to have taken this first step tentatively, and we believe that it will only moderate other liraization policies gradually.”
Meanwhile, Gökçe Çelik, senior economist at UniCredit, commented on the monetary policy path:
“Mr. Erdogan might tolerate this hybrid policy mix for longer if the [Justice and Development Party] performs well in local elections. We think calls on the CBRT to lower rates could resume later in the year, if not already before the local elections. The higher the policy rate, the louder the calls to reduce it again, in our opinion.”
Analysts at the EIU added:
“Meanwhile, uncertainty surrounding Mr Erdogan’s commitment to orthodox policies will remain. Many decisions have yet to be taken. Despite depreciating after the elections in May, the lira has arguably not yet been left to float freely. No timetable has been announced for phasing out the guarantees provided for the “exchange-rate-protected” bank accounts (KKMs). A programme for reducing the growing fiscal deficit has yet to be developed. Banks continue to operate under many unorthodox rules and regulations intended to control the direction and cost of credit and demand for foreign exchange.”