© Reuters. A woman holds Turkish lira banknotes in this illustration taken on May 30, 2022. REUTERS/Dado Ruvić/Illustration
Written by Mark Jones
LONDON (Reuters) – The Turkish lira fell 7 percent on Wednesday as the newly re-elected government appeared to abandon its costly 18-month strategy of keeping the currency taut by any means necessary.
Ankara has seen decades of hardship in financial markets, and the charts below show the challenges that a weak lira poses to the country’s new economic decision-makers.
1 / Let’s go?
The combination of a huge budget hole, an inflation problem, thanks to a few years of very questionable policies, and a meager pile of foreign exchange reserves means that there are plenty of reasons for the lira to continue falling.
If or where it stops, no one really knows. Analysts in Wall Street giants such as JPMorgan (NYSE:) and Goldman Sachs (NYSE:) and the foreign exchange futures markets believe that 25 or even 30 per dollar could be possible, marking another big drop from even record lows on Tuesday.
Much will depend on whether the central bank raises interest rates now in the big way it has done during other times of turmoil, or even introduces capital controls — something the authorities in Turkey have long insisted is off the table.
However, the central bank is widely expected to get a fresh head start in the coming days. That will almost certainly be followed almost immediately by a significant volume hike, to somewhere in the region of 25% to 30% from the current 8.5%, JPMorgan predicts.
“This is what happens when you get exponential movement – for a long time you don’t think something is happening, and then suddenly everything collapses,” added Ulrich Leuchtmann, head of forex research at Commerzbank (ETR:) in Frankfurt.
2/ No gain, no pain
A potentially steep rate hike could easily bring the Turkish economy to a standstill again, or worse, send it into recession, as consumers tighten their belts and businesses watch borrowing costs explode.
Some of the pain could be offset by the export-stimulating weaker lira that will likely further boost the upcoming tourism season and reconstruction spending following the devastating earthquake in February.
“GDP in local currency terms is more at risk of an interest rate correction, as interest rate increases dampen rampant credit growth, than devaluation per se,” said Hasnain Malik of Tellimer.
Boom and deflation cycles are no stranger to the Turkish economy, as it has oscillated between double-digit growth and deflation rates in recent years. In its latest spring forecast, the International Monetary Fund predicted an expansion of 2.7% for 2023.
3/ Castor swell
The lira’s decline will raise fears of a new spike in inflation in the country that only last year saw it soar to 80%.
Monday’s data showed headline inflation fell below 40%, although that was partly due to Erdoğan providing freedom to Turks in the run-up to the elections.
Analysts were already expecting the price to rise as high as 50% before the currency’s latest plunge, and Tellimer’s Malik said it may now return to last year’s peak levels as both free gas and FX moves through the system end.
“It’s inevitable,” said Keren Curtis, head of emerging market local currency debt at Abrdn, referring to the lira’s slide this week.
“There will be more inflation, so it’s hard to say what would change that without a big increase in interest rates.”
4/ Accounting problems
One of the costs Turkey now faces is covering the private lira-protected bank accounts set up by the government and central bank in late 2021 to persuade Turks not to convert all their money into dollars or gold.
Frank Gill, chief sovereign debt analyst at credit rating agency S&P Global (NYSE: ), estimates that if the lira falls to around 26.5 per dollar — 20% lower than it was after President Recep Tayyip Erdogan’s re-election on Sunday — compensation will be compensated. The cost will be just under 3% of GDP.
However, he added that compensation will be paid to depositors in lira instead of dollars or euros, and this bill will be divided between the treasury and the central bank.
5/ The debt dilemma
The other big problem is that $100 billion in debt has been borrowed by governments, businesses and households in Turkey in dollars or euros — loans that are now getting more expensive to service unless you’re a company whose goods are also sold in dollars anyway.
If the debt cannot be repaid, the banks that gave out the loans also have a problem as their balance sheets will start to make holes unless they have hedged themselves accordingly.
It could have broader ramifications, too. Fund managers at NinetyOne estimate that when countries at risk of default in the CCC rating are excluded, Turkey accounts for nearly 60% of all “high-yield” emerging-market sovereign debt payments due for each of the next four years.