❗ Lira lost over 50% against USD this year. Actions by Turkish authorities boosted currency by over 30% this week. What's next for TRY?
How did it all start?
Turkey is considered an emerging economy, located at the frontier of Europe and Asia. In spite of the close proximity of the Middle East, the country does not have significant natural resource reserves like Arab countries do. Because of that Turkish economy is import-oriented, which leads to a large current account deficit. This, in turn, means that Turkey is reliant of foreign debt.
2018-2019 crisis
Turkey for years tried to be perceived as investor-friendly. Relatively high interest rates attracted investors but were unable to cool inflation. Price growth has exceeded the already-high inflation goal, what led to TY weakness and investors' exodus from the country.
Turkish inflation accelerated beyond 20%. Will new actions be enough to stabilize prices and domestic currency? Source: Macrobond, XTB
Central bank reacted to the worsening problem by lifting interest rates and intervening on the FX market. However, those actions failed to bear fruit and extremely high interest rates began to worry the Turkish President. Erdogan start to exert more pressure on the central bank and hamper its independence. Adding deterioration in US-Turkey ties on top of that led to a major TRY crisis, which forced CBRT to boost the main interest rate to 24%.
Reasons behind the recent crash on TRY?
Reasons behind the current TRY weakness are similar to the previous currency crisis in Turkey. Lowering interest rates under pressure from Erdogan triggered an extreme currency depreciation. High debt, rampant inflation, poor relations with western countries and lack of central bank independence pushed Turkish lira to fresh record lows.
Rally of Turkish lira
In order to ease burden of plummeting currency on citizens and the economy, Erdogan and his administration decided on a set of measures aimed at stabilizing the situation. Turkey will guarantee domestic TRY accounts and pay interest on those accounts that will offset FX losses. Action is aimed at promoting holding savings in TRY and halting flight to foreign currencies and assets. Turkish government will also provide companies with forward contracts that will help hedge against FX volatility. However, those actions are unlikely to ease inflationary pressures and given reluctance towards rate hikes and rising energy prices around the world.
This is of course one side of the story behind recent TRY gains. The other one is a massive FX intervention by the central bank and trimming of bets against the lira by investors. Combination of those factors led to gargantuan moves on TRY market at the beginning of this week.
Nominal moves of USDTRY during the most recent crisis were quicker and bigger than in the case of previous one. However, if we take a look at relative moves (in %), we can see some analogies. Nevertheless, new actions announced by Turkish authorities may not be enough to slow inflation. Stability of TRY may not last long if inflation continues to accelerate. Source: xStation5
What's next?
There were different methods used in the past in order to stabilize currency. Some countries implemented interest rate corridors, other decided on high late-liquidity interest rates. However, those actions never resolved the situation for long. While the new plan announced by Turkey may seem rational, stability on the FX market is unlikely to last long. If TRY FX rate remains floating, speculators should soon return to shorting Turkish lira and testing limits of central bank and government ability to defend the current. Without a clear plan and actions aimed at cooling price growth, another period of TRY weakness seems to be a matter of time.
Real interest rates in Turkey are not only negative but also the lowest in the world. Without a return into positive territory, price growth may be hard to stabilize. Source: Macrobond, XTB
Turkish lira gained significantly but it was to a huge extent driven by closing of short positions. Taking a look at Turkish CDS, we can see that there is barely any change in risk of default following announcement of new actions by the government. It means that large institutional investors do not see a material improvement in terms of fundamentals. Source: Bloomberg
