After a period of relative stability during March and April this year, the lira’s downward trajectory once again picked up pace in May.
Turkey’s trade ministry has been keen to paint a positive picture, noting that use of the lira in foreign trade rose by 72% in the first three months of 2022. However, Mustafa Sonmez, a Turkish economist, and Atilla Yesilada, Turkey country analyst at GlobalSource Partners, point out that the currency’s share of Turkish foreign trade is miniscule compared with the 71% that is denominated in dollars and 21% in euros.
“Despite high inflation, the [Turkish president Recep Tayyip] Erdogan administration’s strategy continues to widen the current account deficit, which is likely to hit $30 billion next month,” says Sonmez. “The amount of external debt to be paid over the next 12 months exceeds $175 billion.”
At the end of April, Erdogan told reporters that inflation would begin to fall after May. Earlier this month, treasury and finance minister Nureddin Nebati suggested that the government would introduce inflation-linked bonds for individual investors and predicted “a significant decrease in inflation in the coming period with the normalization of commodity prices, the stability in the exchange rate and the additional steps we will take.”
But few external observers are convinced that any of the measures already taken or planned will have the desired effect.
Despite high inflation, the Erdogan administration’s strategy continues to widen the current account deficit, which is likely to hit $30 billion next month
Mustafa Sonmez, Turkish economist
An individual choosing the FX-protected deposit scheme receives an interest rate of roughly 20%, whereas the consumer price index increased by more than 7% in April alone – with the prospect of more to come.
“This suggests that deposit holders will either return to hard currencies or draw down their savings,” adds Yesilada.
The central bank beefed up its FX reserves briefly during February when it managed to unwind approximately $7 billion from its swap book. But Cristian Maggio, director and head of emerging markets strategy, rates and FX at TD Securities, notes that market conditions were supportive at that time, while new international swap lines signed with foreign central banks also helped.
“Daily swap activity has been on the upside since early March, pushing the overall swap book back to around $41 billion,” he explains. “Burning reserves or building ever-growing swap positions has shrunk the amount of adjusted net FX reserves held at the central bank and yet USD/TRY has recently moved above the 14.75 level the central bank has tried to protect for some time.”
Negative pressure
Ipek Ozkardeskaya, senior analyst at Swissquote, says that protecting lira deposits against depreciation is increasingly costly for Turkey as the currency is under negative pressure from policy rates that don’t match economic fundamentals.
“Official inflation in Turkey exceeded 61% in April, whereas the unofficial data printed 156% for the same month and the policy rate is 14%,” she says. “As a result, rising inflation becomes a heavier weight to carry. However, the central bank and the government have put all their weight behind the de-dollarization of the Turkish economy and will maintain the current policy as long as they can afford it.”
Dennis Shen, lead analyst on Turkey at Scope Ratings, agrees that the lira compensation scheme has placed a heavy budgetary burden on the treasury, especially after expansion of the programme from coverage of only retail depositors to providing protection for companies, Turkish nationals living abroad, and foreign citizens and entities.
“In the end – especially as inflation-protected accounts pick up in use – protection of lira deposits is likely to prove unsustainable during future periods of more significant depreciation forces against the currency,” he says. “The only question is how much damage the scheme does to the public finances before it is scaled back and/or cancelled, potentially with modifications of terms of existing accounts if the programme becomes unsustainable in the middle of a future crisis.”
Victoria Scholar, head of investment at Interactive Investor, notes that it has become a lot more challenging for the central bank to intervene to keep the lira below 15 against the dollar, given the strength of safe-haven demand for the dollar combined with nervousness towards emerging markets in light of Russia’s invasion of Ukraine and China’s draconian Covid lockdown measures, which have prompted a series of emerging-market growth downgrades.
In the absence of large foreign credit or hot-money flows, the central bank will have to cease intervening in the currency market, triggering another currency shock, according to Yesilada.
“Even a good tourism season will not save Turkey, as long as oil, gas and grains prices hover at current ranges,” he says.
Crypto appeal
There are also signs that Turks are increasingly turning to crypto to preserve their savings against currency devaluation. A survey published by Aksoy Research in late March suggests that more people would invest in cryptocurrency than in the domestic currency despite the various schemes introduced to encourage lira holdings.
According to the Chainalysis 2021 Geography of Cryptocurrency Report, 92% of all cryptocurrency sent from Turkey-based addresses is sent abroad (more than any other country) and the Turkish crypto market is worth more than the Middle East combined.
Maggio at TD Securities says broad-based, sweeping capital controls are unlikely since Turkey needs hard currency and capital controls work two ways, making inflows as much if not more difficult than capital outflows.
“Minor restrictions are always possible, but they are unlikely to change the big picture,” he adds.
Shen notes that the requirement for 25% of exporters’ foreign currency revenues to be converted to lira is a form of currency control and adds that even the lira deposit scheme represents a type of indirect currency control as it incentivizes holdings of deposits in domestic currency.
“Further restrictions or changes to existing capital controls are likely as Erdogan pursues currency stability for a crucial period ahead of scheduled 2023 presidential elections,” he says. “The president is counting on such measures keeping the exchange rate under control and arresting spiralling inflation.”
These observations contribute to a sense that while Turkey skirts close to another currency disaster, the ruling AK Parti has yet another new trick up its sleeve.
“Next in line might be guaranteeing a fixed dollar return to global funds which invest in lira government bonds,” says Yesilada. “Then a one-year bond indexed to inflation for domestic savers could be deployed. But these are shortcuts that will have only a fleeting impact. The central bank will have to enact a draconian rate hike or Turkey will have to impose currency controls.”
The most damning assessment of the lira’s prospects comes from Oanda senior market analyst, Craig Erlam, who says the currency is unlikely to come back into favour any time soon because the institutions that influence it are not viewed as credible or reliable.
“As we have seen from their actions and disregard for the data, there is no indication that a more sensible approach will be taken – which will continue to make people very nervous,” he concludes, “especially at a time when central banks around the world are raising rates, making the lira vulnerable to further plunges.”
Lack of independence at the central bank and a widening current account deficit continue to place strong depreciation pressure on the currency concludes Brendan McKenna, international economist at Wells Fargo Securities. “Unless those dynamics change suddenly, we expect the lira to trend weaker and to be an underperformer within the emerging market FX complex.”
