OPINION: Is TL sinking because of Turkey-US tensions?18 December 2019
Turkey and Argentine, united in a bad curse are the candidates for a second year in a row to finish the year as the two worst performing EM currencies. Reuters wrote on 17 December:
“Turkey’s lira declined more than 0.5% on Tuesday to its weakest level in two months, as concern over relations with the United States lingered and a lower real yield on the currency lessened its allure.
The lira has weakened some 10% this year, because Ankara’s ties with Washington have been strained over a host of issues, including policy differences in Syria and Turkey’s purchase of an S-400 missile defense system.
The currency traded at 5.8820 against the dollar at 1434 GMT, weakening some 0.6% from Monday’s close of 5.8480. Earlier, it reached 5.8845, its weakest level since Oct. 17”.
Lira depreciation comes at bad time because for seasonal reasons Turkey’s trade deficit, and in particular energy imports are on the rise, as Brent crude surpassed $65/barrel, adding strains on the spot market and the inflation picture.
However, are the escalating tensions between Turkey and the US the primary reason for the weakening of the TL? I doubt it.
The most important argument why the Lira is currently showing weakness is probably of a political nature, claims Finance Market News.
“According to recent reports, President Erdogan has threatened the USA with closing the Incirlik air base used by the USA. It concerns possible US sanctions against Turkey. It also concerns a possible reaction of Turkey to the recognition of the Armenian genocide in the First World War by the US Senate. Incirlik lies in the southeast of Turkey”.
President Erdogan is also alarmed that Trump will not be able to stop the swelling movement in American Congress to sanction Turkey for the purchase of Russia-made S-400 anti-missile systems.
While this reason is perfectly valid, there are more important factors in the background which undermine the currency. The first of these is also mentioned in the a.m. Finance Market News Report:
“The Turkish Lira is depreciating. What is going on? We go on a small track search, and begin on last Thursday. The Turkish central bank lowered the key interest rate from 14% to 12%, with the market expecting a reduction to 12.5%. In just a few months, the central bank cut the key rate four times, from 24% to 12%”.
Commercial banks are matching policy rate cuts with lower TL deposit rates at a time when monthly CPI is on the rise again, essentially forcing Turkish retailers to switch to FX deposits. This migration creates demand for spot FX. The migration is exacerbated by the fact that at least 40%, perhaps as high as 70% of participants in recent polls think Turkstat underestimates inflation stats. In other words, the perceived ex-ante real rate of return on TL deposits is steeply negative.
The second reason not mentioned in the financial press is the upcoming year-end interest payments of Turkish corporates on their foreign debt, to finance which they may be buying FX in the spot market. Currency hedging through derivates is rarely used in Turkey.
Finally, the Erdogan administration may be turning a blind eye to some currency depreciation to breathe life into dormant export, which failed to increase for three months in a row, in the false belief that a weaker currency renders Turkish exports more competitive. It won’t, but this is the subject matter of another article. In the past flare-ups of currency volatility, state banks acting on behalf of Treasury and using swap transactions with Central Bank heavily sold FX to defend the local currency. This time they seem absent from the spot market, which stregnhtens the argument that Ankara condones a small amount of currency depreciation.
If I am correct in my views, US sanctions and potential retaliation by Ankara are not fully discounted in the exchange rate and as Central Bank cuts policy rates once again in January MPC meeting, dollarization will gain speed. It remains to be seen whether state banks can stop the avalanche which they are watching from the sidelines now.