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Turkey: Syria and Basci extend lira’s free fall

Threat of military action adds uncertainty; central bank inactivity supporting volatility.

The threat of western military action against the Syrian government and policy torpor at the central bank have breathed fresh volatility into Turkish financial markets, extending the lira’s freefall against the dollar to fresh record lows. Since May, the lira has fallen by more than 10% against the dollar as civil unrest combined with the prospect of an end to quantitative easing has forced investors to slash exposure to Turkey and emerging economies more broadly.

The twin effects of the threat of a US-led military strike against the Assad regime and the central bank’s unwillingness to intervene with new effective measures to halt the lira’s slide have since exacerbated investors’ nervousness, analysts say.

“Unfortunately we are now at a juncture in emerging markets investment where investors are looking for the safest possible place without any possible surprises. That’s something you have to keep in mind when thinking of Turkey,” says Mark Mobius, executive chairman of Templeton Emerging Markets Group.

Turkey is one of the more vulnerable emerging markets, thanks to its large current account deficit, relatively low foreign exchange reserves and geographic proximity to Syria.

But in late August, central bank governor Erdem Basci ruled out further rate increases to support the lira, telling the state news agency he would keep core rates at 6.75% until inflation falls to 6.2% from the current 8.8% by the end of this year.

Economists had expected Basci to step up his rhetoric against the lira’s fall, but instead he said the central bank “won’t step back on interest rates”, and that he sees the drop in the lira as temporary.

“We and the market were expecting governor Basci to make hawkish comments, given significant lira underperformance of late,” says Mohammed Kazmi, emerging markets research analyst at RBS. “Disappointingly, this did not come to fruition, as the governor appeared to dismiss the obvious concerns surrounding the lira.”

Kazmi adds: “Although governor Basci was quoted as saying: ‘Believe in me and win’, the market is less convinced, given the central bank’s track record of late. A move towards orthodox monetary policy is clearly necessary at this time; however, it appears as though the central bank will persist with its unorthodox policy, with the effectiveness of current and upcoming new tools questionable.”

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