The Lira plunges, stocks plunge, yields jump. Capital controls expected.
By Nick Corbishley for WOLF STREET:
After four months of relative calm, the Turkish lira is once again doing what it does best: slumping against every major currency. It nose-dived 17% overnight to near all-time lows, hitting 8.39 against the dollar and 9.97 against the euro before recovering later on, ending the day down over 7% against the dollar, amid concerns that the central bank and state-owned banks cushioned the fall by selling dollars into the market, thereby further depleting Turkey’s already scarce foreign currency reserves. The lira has lost half of its value since its currency crisis began in 2018.
The Borsa Istanbul Index suffered one of its steepest selloffs in years, before triggering circuit breakers that halted trading. The BIST 100 Index ended the day down 9.8%. Yields on Turkey’s lira-denominated 10-year bonds soared from 14% to 19%, as investors rushed for the exits. Investors also dumped shares of European banks with close ties to Turkey. Spain’s BBVA, which owns around half of Turkish lender Garanti, tumbled 7.5%, its biggest fall since November.
The trigger was President Recep Tayyip Erdoğan’s snap decision on Friday evening to fire the governor of Turkey’s Central Bank, Naci Ağbal, who on Thursday, in order to tamp down on surging inflation and to prop up the lira, had engineered a shock-and-awe 2.0 percentage-point hike of the policy rate from 17% to 19%, when economists had expected a rate hike of half that magnitude. It was the third time since mid-2019 that Erdogan has sacked a central bank chief.
Ağbal himself occupied the post for only four months. Following his appointment in November, just after the lira had hit a record low of 8.58 per dollar, he regained market trust by hiking interest rates above the official rate of inflation. The day after his appointment, Erdogan’s son-in-law, Berat Albayrak, resigned as Turkey’s finance minister, raising hopes that Erodgan might reduce his influence over the central bank. Foreign funds began flowing back into the country. This helped to arrest and even reverse “the damaging trend of dollarization” — when a country’s populace uses the US dollar in addition to or instead of the domestic currency — says Societe General strategist Phoenix Kalen.
In just four months, the lira rallied 18% against the dollar as investors were lured by the highest real interest rate in emerging markets after Egypt’s. But Ağbal’s sharp hikes in interest rates had sapped demand for new loans.
“We’re seeing a significant deceleration in lira lending growth — all banks are seeing less demand for borrowing because of high interest rates,” said Sevgi Onur, vice president and banking analyst at Seker Invest in Istanbul, in early March.
Turkey’s debt-dependent economy cannot grow without strong growth of debt. Hence Erdogan’s decision to replace Ağbal. In the space of just one day’s trading, four months’ worth of gains evaporated.
Most investors were not impressed with Ağbal’s replacement: Sahap Kavcıoğlu, a lecturer in banking and a former executive of a state-run bank who apparently shares Erdogan’s belief that lowering interest rates helps to keep inflation in check. The big fear now is that Kavcıoğlu will try to reinvigorate borrowing by lowering the interest rate below the rate of inflation, which clocked in at 15.6% in February.
For the moment, the government and the central bank, which are more or less one and the same thing, are trying to soothe market jitters. The new central bank governor Kavcıoğlu said in a statement that future MPC meetings will be held as scheduled on April 15, signalling that there will be no imminent emergency rate cut.
Despite last year’s currency crisis, Turkey’s economy grew by 1.8% in 2020, emerging as one of only a handful of countries in the world to avoid a contraction in GDP. But that growth was largely fueled by a huge surge of lending by the central bank and state-owned banks, which are controlled by Erdoğan through his chairmanship of a sovereign wealth fund.
This cheap lending further depleted the country’s foreign currency reserves. Fears are now rising that Turkey’s central bank will not have the firepower needed to defend the currency over the coming months after reportedly burning through over $100 billion in foreign reserves since early 2019.
“Without much remaining reserves to defend the currency, and considering an expected exodus in foreign and local investor capital, it may be difficult for Turkey to avoid another currency crisis in the coming months,” Kalen said.
It will be Turkey’s third in three years. The more the lira falls, the more inflation will rise in Turkey’s import-dependent economy. The more inflation rises, the more people will turn to the dollar or other hard currencies to protect their savings. Once the central bank brings real interest rates back into negative territory, it will probably bring back the soft capital controls that prevailed during Berat Albayrak’s tenure in an attempt to stabilize rates. But the economy is still weak. The virus crisis wiped out a big chunk of the nation’s revenue from tourism. Now, the newly plunging lira is going to make it even harder for Turkey’s struggling companies to service their foreign-denominated debts. By Nick Corbishley, for WOLF STREET.
“A front-loaded and strong additional monetary tightening.” Read... Shock-and-Awe Rate Hikes Begin in the Emerging Markets amid Surging Inflation
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