The rollercoaster in the lira during the past year has unnerved even battle-hardened investors with memories of the bad-old days of emerging markets.
From a peak of around 1.8 against the dollar 12 months ago, the lira lost around 10% of its value last summer, hitting 2.0 to the dollar after a political corruption scandal and the first Fed tapering announcement.
When the tapering officially began in December, the lira slid again, to around 2.35, giving it a full peak-to-trough decline of around 20%.
The rout occurred before the Central Bank of the Republic of Turkey (TCMB) took the decisive, though some cast as belated, action of hiking the interest rate from 4.5% to 10% at the end of January, stabilizing the currency. It has since regained some of that lost ground and is at around 2.1.
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| The lira lost around 10% of its value last summer, hitting 2.0 to the dollar |
Yet some believe there is more pain to come. Turkey ended 2013 with an eye-watering current-account deficit of 7.9% of GDP, with analysts predicting an end-year deficit of a still-high 6%, though that is off from the 10% deficit notched in 2011.
“Economies that in one way or another have been living beyond their means in recent years could find themselves back under the spotlight as global monetary conditions tighten,” predict the Capital Economics analysts.
As well as South Africa and parts of Latin America and southeast Asia, they cite Turkey as an example of this concern.
“We are especially concerned about the sustainability of credit growth,” they say.
While the country is not alone in this group, Neil Shearing, chief emerging markets economist at Capital Economics, believes Turkey stands out as the riskiest of the leading economies as a result of the confluence of economic and political factors.
“I currently own a long USD/TRY position due to my expectation for greater domestic political turmoil and Fed tapering,” says Adam Myers, European head of FX strategy at Crédit Agricole CIB.
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However, he believes he is in a minority, with most foreign investors overlooking such factors and maintaining lira longs. Some analysts reckon the relative resilience of the lira in recent months is the fact the South African rand – another high-beta currency, in a current-account deficit economy, exposed to Fed-tapering risk – is cheaper to short.
“It largely depends on what the [Turkish] central bank decides to do,” says Emre Akcakmak, portfolio manager at East Capital. “The rate hike is evidence the TCMB has come to its senses, it was long overdue and loose policy was one of the main causes of the volatility we saw before. We do not expect it to cut rates aggressively – the focus is now on bringing inflation down.”
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| Erdem Basci, governor of the TCMB |
Whatever action Erdem Basci, the governor of the TCMB, takes – in the teeth of political pressure given president Recep Tayyip Erdogan’s perverse view that high rates will feed inflation – it will be against the backdrop of considerable domestic and global pressure.
The Bank’s mandate is to maintain price stability, but the government has been calling for it to incorporate growth targets, despite inflation running at uncomfortably high levels.
Yet, with the May headline inflation figure coming in at 9.7% – better than many expected – some believe an easing of inflationary pressure might be in sight. The inflation announcement on Tuesday led to the lira posting gains against other currencies later that day.
“Provided global market stability is maintained, real yields at current levels are not yet low enough to destabilize the currency,” says Morgan Stanley in an EM strategy briefing. However, it warned “the fact that core inflation has continued to move higher suggests a cautious approach is warranted”.
Akcakmak believes inflation will peak in May or June and decline to below 8% by the end of the year, accommodating gradual cuts in the second half of the year. “Monetary policy itself is not a problem for lira, but premature rate cuts may be source of further volatility,” he warns.
As for the debt, although private debt is building fast, Akcakmak believes this is offset by public debt remaining relatively low, whilst currency mismatches – between foreign-denominated liabilities and assets in local currency – are relatively well-contained. With its newly won investment-grade status, Turkey has extended the maturity of its debt and reduced the cost of servicing it.
“It is an emerging problem,” says Akcakmak. “In the short term, the problem is maintaining flows to service the current-account deficit.”
Much, therefore, hinges on the TCMB keeping a lid on inflation and politicians finding a way to appease angry voters.