Turkey’s Cratering Markets Stoke Speculation Over Extreme Measures

August 8, 2018 Updated: August 8, 2018

Desperate measures are in the air in Turkey: trading rooms are awash with talk of a bailout by the International Monetary Fund and potential capital controls. But there’s a vacuum at the core of economic policymaking.

The central bank and government have remained largely silent as the currency plummeted to record lows and the U.S. imposed sanctions and threatened more. The lira rebounded after falling by the most in a decade on Aug. 6, getting a lift from news that Turkish officials were headed to Washington for talks. The yield on 10-year bonds surged above 20 percent to an all-time high.

Capital controls have “become more than a tail-risk scenario now as the authorities show no signs of reverting to more orthodox policies,” said Shamaila Khan, AllianceBernstein’s director of emerging-market debt in New York. But what the lira really needs is “independence of the central bank, tighter fiscal policies, and an IMF program.”

Yet the radio silence from Ankara is deafening. President Recep Tayyip Erdogan, who won almost absolute power in June elections, is a staunch critic of higher interest rates and investors worry that he may be standing in the way of the central bank.

“It is very difficult to foresee an about-face by the authorities,” said Per Hammarlund, chief emerging-market strategist at SEB in Stockholm. “The moment when Turkey will be forced to go to the IMF for support is drawing closer.”

Buckling Lira

The lira is buckling under the weight of one of the widest current-account deficits in emerging markets and inflation is spiraling ever higher. As of July, it was running at more than three times the central bank’s target, driving the real policy rate to below 2 percent, the lowest since December.

The lira was 1.4 percent stronger at 5.25 per dollar at 5:30 p.m. in Istanbul (10:30 a.m. EST) after sinking as much as 6.7 percent to the dollar Aug. 6, taking the currency’s slide to 28 percent so far this year. Ten-year yields fell 18 basis points after earlier surging as much 42 basis points to a record 20.09 percent; the benchmark stock index was up about 2 percent, narrowing its year-to-date loss in dollar terms to about 40 percent.

Although investors are pushing for a significant rate increase from the central bank, there is growing consensus it is going to take more than monetary policy to reverse the tide.

“It’s going to be a shock of one type or another: either a policy shock or a macro shock or some combination of the two,” said Christopher Granville, managing director for EMEA and global political research at TS Lombard in London. “But the way to sugar that pill,” he said, would be a “political accommodation with the West. That would make the pain much less.”

Turkey’s deputy foreign minister Sedat Onal was leading a delegation with officials from the finance, justice and foreign ministries to the U.S., the foreign ministry in Ankara said in a statement, fueling speculation that a deal to patch up relations—strained by Turkey’s detention of an American pastor—may be in the works.

The U.S. remains a solid friend and ally of Turkey, the U.S. embassy in Turkey said in a Twitter post, as it denied news in Turkish media that a U.S. official predicted the lira would weaken to 7 per dollar.

Sugar Pill

On Aug. 6 the central bank boosted banks’ access to dollar liquidity by $2.2 billion, an effort to take some pressure off the lira. The currency trimmed its losses briefly, only to plunge to successive record lows through the night as investors saw the move as evidence that the bank’s hands were tied.

The lira’s meltdown is not only hurting consumers’ sentiment and wallets, but it’s pushing corporate balance sheets closer to the abyss. Companies that borrowed heavily in foreign currencies now face a growing burden due to the tanking lira.

Turkey Inc. is weighed down by $337 billion of foreign-exchange liabilities, with a shortfall of $217.3 billion net against assets, according to central bank data. Bank borrowing costs are also rising ahead of more than $100 billion in debt payments coming due over the course of a year.

“It will remain like this until the central bank commits unconditionally to hike rates and keep them high until inflation has turned,” Henrik Gullberg, a strategist at Nomura International Plc, said by email. “The market needs that sort of hard commitment.”

“It’s often claimed that the Central Bank of the Republic of Turkey cares less about the level of the lira and more about its speed of decline. It’s got reasons to worry about both now: the currency has tumbled to a historic low and at a record speed. With no monetary policy meeting scheduled until September 13, an emergency rate hike is a real possibility.”  Ziad Daoud, Bloomberg Economist

From Bloomberg