Last updated: 13:05 / Wednesday, 15 August 2018
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Turkey’s Crisis: Policy Response Disappointing So Far

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Turkey’s Crisis: Policy Response Disappointing So Far

Turkey is in the midst of an economic crisis. On August 10th their assets suffered greatly and their currency has fallen to historical lows after President Trump said last week he was doubling the amount of steel and aluminum tariffs on the country. On Wednesday, Tayyip Erdogan doubled import tariffs on some US imports (cars, alcohol, tobacco, cosmetics) and a Turkish court rejected an appeal for the release of a jailed American pastor at the center of the spat between Ankara and Washington.

The Turkish economy remains vulnerable as its current account deficit is the widest among emerging markets (The United States had a trade surplus with Turkey in 2017 of nearly 330 million dollars) and inflation levels are nearly three times the central bank’s target. Aneeka Gupta, analyst at WisdomTree mentions: “The perception from the investment community is that monetary policy in Turkey is not independent as President Erdogan is opposed to higher interest rates, so the central banks would need to defy the president and raise rates to defend the currency and avoid a default scenario.”

According to Delphine Arrighi, fund manager, Old Mutual Emerging Market Debt Fund, Old Mutual Global Investors, the worsening of political tensions between the US and Turkey has been the final blow to an already dire economic situation, with the collapse of the lira now rapidly fuelling concern of a full-blown currency and debt crisis given the amount of USD-denominated debt in the private sector. More over, the meetings between the banking regulator and the central bank over the weekend haven’t yielded the results the market was expecting. “Although the recent measures announced by the Central Bank of the Republic of Turkey (CBRT) will aim to ease onshore liquidity, they will fall short of restoring investors’ confidence. At this stage, the lack of credible policy response is pushing Turkish asset prices into a tailspin” Arrighi mentions adding that “given the reluctance of the CBRT to hike rates at its previous meeting and President Erdogan’s recent comments blaming an international conspiracy rather than acknowledging the real economic crisis resulting from an overheating economy faced with tighter global financial conditions, there is little hope for a return to orthodox policies at this stage”.

Arrighi suggests to include capital controls, “which seem more likely than an appeal to the IMF, but that would certainly not be the least painful and would most likely precipitate a recession while postponing the return of portfolio inflows. Hence a sizable rate hike followed by drastic measures of fiscal consolidation still appear as the most viable option to re-anchor the lira and pull the Turkish economy from the brink. This is very much like what Argentina had to deliver. We doubt the political will is there in Turkey and so more pain might be needed to force policy action. Some resolution of the political spat with the US could lead to some near-term relief in the currency, but this is unlikely to be sustainable if not accompanied by credible economic actions.”

Ranko Berich from Monex Europe mentions that "Normally when a currency falls 10% in a day, political and monetary authorities scramble to promise fiscal discipline and central bank independence. Instead of doing this, Erdogan has reached for the crazy stick and given the lira another whack in a rambling speech that focussed more on combative rhetoric than addressing market concerns… The lira’s issue now isn’t if the central bank is willing to raise rates high enough to combat the coming inflationary shock, but one of credibility. Erdogan’s son in law and economy chief, Berat Albayrak, also gave a speech in which he spoke in favour of central bank independence, so this may represent a sliver of hope for the lira. But the pressure is now on the TCMB to announce a drastic tightening of monetary policy in the order of a 5-10% increase in rates to demonstrate that it has the political mandate to fight inflation and stem the lira’s losses."

Dave Lafferty, Chief Market strategist at Natixis Investment Managers, adds that: “This risk to EM contagion is sentiment, not fundamental. Turkey has limited trade and economic ties to other EMs. However, market reaction can throw the baby out with the bathwater as we see with other fragile EMs like Argentina and Hungary, who both saw steep currency losses in sympathy with the lira. Argentine CDS also spiked although Hungary CDS held reasonably steady.”

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