Turkey’s Central Bank Can’t Stop the Lira from Crashing

Turkey’s currency became worse because of a market selloff in emerging market economies after Donald Trump’s surprise victory in the U.S. elections. Trump has expressed a protectionist stance that could weaken emerging economies. The U.S. Federal Reserve also went ahead to raise interest rates – a move that could burden countries with USD-denominated debts. Hence, it wasn’t strange that the Lira is almost 7% down against the USD.

Turkey’s Central Bank Can’t Stop the Lira from Crashing

 

The Turkish Lira (Turkey’s currency) has been under pressure since the failed coup attempt to oust Edrogan in July last year. The government declared a state of emergency and the Lira has been on a downward spiral ever since. On Tuesday (January 10), the Lira lost as much as 1.9% in the forex markets to mark its fourth consecutive record low in the New Year. This piece examines some factors behind the Turkish central bank’s ability to stop in the freefall in the Lira.

Turkey’s central bank is under political pressure to keep interest rates low

No responsible central bank will be happy seeing its currency heading down a slope without making efforts to halt the decline. The Turkish central bank knows that pushing an increase in interest rates could slow down the descent in the Lira’s value.

The central bank however cannot go ahead to raise interest rates because the government has a vested interest in keeping interest rates low. The government believes that low rates could boost the weakening Turkish economy and the Turkish central bank is making a ‘smart’ political move to avoid going against the wishes of the government. Nonetheless, the Turkish central bank is pushing some palliative measures that could instill confidence in the Lira and the Turkish economy.

The central bank says it will tweak its policy framework to support the Lira. The central bank noted in a statement that “Exchange rate movements due to recently heightened global uncertainty and the increase in oil prices pose upside risks on the inflation outlook… Developments will be closely monitored in order to make a sound assessment regarding the net impact of these factors.”

Nonetheless, William Jackson, a senior emerging-market economist at Capital Economics notes that such tweaks won’t have much effect in boosting the Lira. In his words, “past form suggests that these will have little lasting impact. Instead, it looks increasingly likely that the [monetary policy committee] will need to raise official interest rates at its next meeting.”

Investors exit Turkey’s fragile economy in droves

Turkey along with Brazil, Indonesia, India, and South Africa make up an economic bloc known as the Fragile Five. Indonesia, Brazil, India, and South Africa have managed to rehabilitate trade in their economies but Turkey appears to be left behind. Tatha Ghose, an emerging markets economist at Commerzbank notes that “This is a toxic environment for the lira… It will probably fall further.”

In the light of the current state of things, investors have started taking reducing their exposure to the Turkish economy. Viktor Szabo at Aberdeen Asset Management airs some gloomy concerns when he noted that “Risks in Turkey are still extremely high as we go into 2017 . . . Turkey’s assets are being tarnished by the politics.” Sergio Trigo Paz, head of emerging markets portfolio management for BlackRock’s Global Fixed Income group observes that “They (Turkey) forget to do their homework. The others had to mend their economies and make tough decisions. Turkey did not.”