Turkey is on the verge of a currency crisis that could pose a threat to President Recep Tayyip Erdogan’s re-election bid, and he may have himself partly to blame.
The Turkish lira is down around 24% against the U.S. dollar this year, and has dropped some 16% since the beginning of May, according to FactSet data.
Erdogan last month called for an election on June 24, nearly a year-and-a-half ahead of schedule, in what was seen as a bid to capitalize on his popularity and consolidate power. Erdogan has widely been expected to prevail, but the question now is “whether the recent lira rout has damaged President Erdogan’s polling numbers,” said Phoenix Kalen, emerging markets strategist at Société Générale. Some polls show the opposition gaining traction, she said, which could lead to a surprise outcome.
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“We believe that an opposition win of the executive presidency would spark a phenomenal rally in the lira, possibly reminiscent of the South African rand’s transcendent appreciation in the two months following Cyril Ramaphosa’s December 2017 victory at the ANC elective conference.”
The rand USDZAR, +0.5700% rallied 1.9% in the first half of February, when former leader Jacob Zuma stepped down and Ramaphosa took over.
The lira USDTRY, +0.1763% dropped in part due to Turkey’s weak economic fundamentals — including its double-digit inflation numbers, which have only gotten worse amid the lira depreciation — as well as its reliance on foreign funding in a rising U.S. interest rate environment that is making its dollar-denominated debts more expensive. Rising oil prices have also weighed on Turkey’s economy and its currency, as the country is a net oil importer.
Moreover, Turkey suffered under the general selloff that took hold of emerging markets in the past weeks, inspired by rising Treasury yields in the U.S. Ahead of the lira’s slide, it was one of the most attractive emerging market plays for investors, thanks to the high yields of Turkish assets.
See: Emerging markets feel the pain as dollar, Treasury yields rise
“We will look to assess the altered political dynamics in Turkey before initiating new trades on Turkish assets,” Kalen said. “For now, operating under our pre-existing base case scenario of President Erdogan emerging victorious with the executive presidency and AKP-MHP [alliance] winning majority representation in the Grand Assembly, we envision dollar-lira ending the year at 5.18 and reaching 5.50 by midyear 2019.”
For reference, that would be another 10-17% drop for the lira, given Friday’s level where one dollar bought 4.7201 lira.
AKP is the acronym for Erdogan’s Justice and Development Party, while the MHP is the Nationalist Movement Party. They formed an alliance in February.
Meanwhile, the Central Bank of the Republic of Turkey hasn’t done much to reinforce investor confidence either. The central bank, which historically intervened to support its currency when it dropped around 20%, hiked its late liquidity window lending rate by 300 basis points on Wednesday to stave off the lira’s fall. But by Thursday, the currency’s downward spiral had resumed, leading market participants to expect further intervention.
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The late reaction by the CBRT, as well as its decision to only change the local LLW lending rate, rather than its one-week repo, overnight lending or overnight borrowing rates, wasn’t really inspiring much confidence among investors, said Kalen.
The CBRT has found itself under assault from Erdogan, who has called for lower interest rates despite surging inflation, which hit 10.8% in April. He has threatened the independence of the central bank, telling Bloomberg earlier this week that he planned on being more involved in monetary policy following the election.
“More fundamentally, as long as Turkey’s political rulers espouse unorthodox economic theories and attempt to influence the conduct of monetary policy at the CBRT, we believe that Turkey will find itself trapped in this recurring nightmare of high interest rates, high inflation, collapse of investor confidence, currency crises, and reactive central bank policy-making,” Kalen said.