Turkey at risk of slipping into utter chaos

Financial markets have not been kind to Turkey lately. The Lira has been in a complete tailspin and is hitting new record lows almost every day now. While the EUR/TRY currency pair still stood at 5.50 in July, we closed, at an all-time high for the pair. There are multiple factors causing the Lira slide, with the first being a loss of credibility in the central bank. As inflation has been rapidly rising, investors had expected the Central Bank of the Republic of Turkey (CBRT) to steadily increase interest rates. In fact it is perceived to be behind the curve as consumer inflation jumped to 15.8% in July but with the producer price index already reaching 25%, indicating that the general level of price inflation is rapidly climbing. Investors had expected to see a rise in the central rate but it seems to be stuck at 17.75%. Meanwhile, the budget deficit is heading towards 2% of GDP leaving investors with an uneasy feeling of unorthodox fiscal policy.

In fact, all comes down to policy

President Erdogan had previously appointed his son-in-law, Mr Albayrak, as the new finance minister, as the president increased his grip on the country after the recent election win yielding additional power to the president.

Erdogan is a fierce opponent to higher interest rates. Over the weekend the president claimed that higher interest rates are a gift to the rich and a drag on the poor. At the same time he sees the pressure from the financial markets as proof of economic warfare against Turkey.

The current spat with the US of course does not help. Having detained a US pastor, believed by Turkey to have engaged in terrorist actions, this has enraged President Trump and as a result he ordered tariffs to double on imported steel and aluminium from Turkey. The news was yet another blow to the beleaguered Turkish Lira.

If Turkey therefore wants to calm the situation and stop the rout, we believe, it needs to consider the following;

• increase interest rates to levels where the markets believe the risk for runaway inflation will be limited. This entails letting the CBRT put nominal rates at a level where real interest rates climb to anything between 3 to 5%, keeping them there as long as required.


• implement orthodox fiscal policies which would not spur inflation and leave state finances less fragile.


• end the quarrel with the US.


• regain credibility with the international investor community.

Unfortunately last week’s events, but also comments made by president Erdogan over the weekend, are not very promising in this respect.

Speaking to supporters the president stated ‘interest rates were a tool of exploitation’ and that Turkey was preparing new financial tools versus the US dollar. He also spoke of finding new alliances now that the US has ‘switched a NATO partner for a priest’.

These comments are a clear sign that Turkey looks in no hurry to meet the above points.

Therefore, the Lira may well be in for another turbulent week with more fall-out for Turkish assets or any institution exposed to them. The ECB have already signalled its unrest over the exposure of some Eurozone banks to Turkish assets. Also over the weekend Middle-East banks with links to Turkey saw their shares suffer. That said, contagion for other Emerging Market countries remains limited so far. Other currencies are under pressure which are also hit by US sanctions, or from countries having little forex reserves and/or weak fundamentals. Hence, the Russian Ruble, the Argentinean Peso, the South-African Rand and the Brazilian Real were weaker on Friday.

Back in Turkey, a lot will also depend on how Turkish citizens will react. Apparently it has already become much harder to take out currencies from the bank or to do an electronic fund transfer.

If the Lira plunges will panic spread?

This is very hard to predict. Turkey and its leaders seem very unwilling to turn to the IMF for now. Will stopping Lira convertibility become a considered option? That would obviously be poorly taken by investors and it could wreck Foreign Direct Investment (FDI). Emerging Markets could also succumb to some selling pressure as markets fear contagion even if Turkey looks to be an isolated case.

The conclusion is that one should steer clear from Turkish assets for now as we have very limited exposure as a firm in the Emerging Market funds. It is way too early to hope for a buying opportunity therefore caution should prevail for now. This has not changed our long term view on Emerging Markets, as we have a preference for Asian biased Emerging Market exposure.

Alex Brandreth

Deputy Chief Investment Officer

Source: Bloomberg

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