Turkey’s lira has hit record lows for the past week, thanks to what analysts say is the Turkish government’s unwillingness to balance monetary policy to counter double-digit inflation.
And the fall has been accelerated by geopolitical uncertainty over U.S. and Russian military actions in neighboring Syria.
The currency made a sharp rebound on Friday, however, as top Turkish officials hinted at possible government action with regard to the exchange rate, although without offering specifics. The key question now is how effective those actions will be.
A policy of prioritizing growth over inflation control, led by Turkey’s powerful President Recep Erdogan, has unnerved emerging market investors for some time now. The president, who has called himself an “enemy of interest rates,” has effectively prevented any recent central bank tightening, despite inflation sitting at a lofty 10.23 percent.
Erdogan has called the recent currency sell-off an economic attack by Turkey’s enemies, describing it as “games being played on our economy.”
But investors say that markets have been desperate to see interest rate hikes by the central bank; its last two sessions saw no change in policy, following Erdogan’s calls to keep rates low in order to boost growth numbers.
The lira, which had depreciated 13.9 percent since August to reach an all-time low last week of 4.1944 against the dollar, currently ranks as one of the worst-performing emerging market currencies this year. On Friday, it climbed back 0.74 percent, reaching 4.08 lira to the dollar.
Turkey’s treasury bond yields, meanwhile, have hit multi-month highs and its February current account deficit increased by more than 60 percent on the same period in 2017 to $4.152 billion.
Growth in the country of 80 million has been impressive; real GDP growth in Turkey reached 7.4 percent for 2017, more than twice the previous year’s growth rate and the highest in the G20.
But this rate of growth doesn’t come without risks, said Adrien Pichoud, portfolio manager and chief economist at SYZ Asset Management. “The economy is overheating and has some large imbalances: double-digit inflation and a ballooning current account deficit, both of which are reflected in a weak currency.”
It was this environment, Pichoud noted, that led Moody’s to downgrade Turkey’s credit rating to junk status in March.
Turkish officials and bankers who favor encouraging growth over fighting inflation argue that Turkey is a special case that warrants unorthodox policy, due to its young and rapidly growing population and the need to create jobs.
But the International Monetary Fund (IMF) would beg to differ. Its latest Article IV summary on Turkey praised Turkey’s recovery since the attempted political coup in July 2016, but stated that “the economy now faces signs of overheating: a positive output gap, inflation well above target, and a wider current account deficit.”
This, the IMF warned, makes Turkey more vulnerable to volatility and changing global conditions.
The central bank’s ongoing inaction is more than anything a manifestation of Erdogan’s political control over Turkey’s fiscal policy, experts say. “This underlines the challenges for the CBRT (Central Bank of the Republic of Turkey) in managing the lira when Erdogan has tied both hands behind its back in terms of limiting its ability to hike policy rates,” Bluebay Asset Management strategist Timothy Ash said in a client note.
It’s key to note that Erdogan has his eye on Turkey’s November 2019 elections, and sees continued economic growth as central to his ruling AKP Party’s re-election chances.
In a speech on April 9, Erdogan said, “Some people say this: ‘Too much growth is not a good thing.’ Why? Because they are jealous. It is nothing else.”
But action on interest rates is needed sooner rather than later, Ash said. “And given the past CBRT inaction, the market will be in seeing is believing mode.”
The central bank’s next policy meeting is April 25; in the absence of a rate hike, the lira is likely to fall even further.
