Turkey: Lira slides to fresh all-time low on political noise and mounting economic imbalances
April 4, 2018
The Turkish lira (TRY) slid to a new all-time low in late March as concerns over mounting economic imbalances were compounded by tighter global financial conditions as well as President Erdogan’s renewed feud with Central Bank officials over the optimal monetary stance. The currency trespassed the TRY 4.00 per USD threshold on 28 March, hitting a record low of TRY 4.01 per USD on that day. On 4 April, the lira closed the day at TRY 4.00 per USD, which represented a severe 5.0% depreciation over the same day of the previous month. As of that day, the lira had lost 5.6% of its value year-to-date and was 8.7% weaker in value compared to the same day last year.
Turkey’s economic woes mainly stem from a continued deterioration in the country’s external metrics, caused by persistent double-digit inflation and a rapidly widening current account deficit. In turn, sizeable current account deficits are increasing the country’s external financing needs, for which the country has insufficient FX reserves and depends on highly volatile short-term portfolio inflows. This has exposed the country to shifts in investor sentiment and increase the risk of external shocks, which in early March led Moody’s to downgrade Turkey’s sovereign credit rating further into junk status.
Against that backdrop, a trade spat between the U.S. and China in late March saw investors pulling out from risky markets, which quickly soured appetite for lira-denominated assets. This caused the currency to tumble against the greenback, an effect compounded by multiple speeches made by President Erdogan in recent weeks berating higher interest rates and accusing the Central Bank’s relatively tight monetary stance from causing high inflation. This effectively putting him at odds with orthodox monetary policy and limits the Central Bank’s ability to effectively tame inflationary pressures and stem the weakening of the lira.
Heightened government pressure on the Central Bank, worsening external and inflation metrics and rising interest rates in the United States all suggest the Turkish lira will continue to slide this year. The Central Bank is widely expected to resort to secondary mechanisms, such as adjusting reserve requirement ratios and allowing rediscount loan repayments in TRY, in a bid to contain further lira depreciation; it will only apply hesitant and underwhelming rate hikes in case of a severe lira sell-off. Meanwhile, speculation is rife over a potential early call for general elections, which would further increase political uncertainty and weigh on foreign capital inflows.
USD/TRY Exchange Rate Forecast
All in all, substantial economic imbalances and persistently high political noise are clouding the FX outlook. Our panel expects the TRY to end 2018 at 4.05 per USD, and it projects the lira to depreciate further to 4.22 per USD by the end of 2019.
Author: David Ampudia, Economist