What’s the matter with the Turkish Lira?

The Central Bank of the Republic of Turkey (CBRT) surprised markets this week with a 125-basis point (bp) rate hike. The bank had already hiked the rate 300-bp two weeks ago. Can this move now boost the value of the Turkish lira against the dollar? I don’t think so.

First of all, the CBRT’s surprise move is not considered a sign of its determination to fight rising inflation. It simply looks like a political move to stabilize the lira ahead of the snap elections two weeks from now. The rapid depreciation of the lira has always been considered a prime sign of economic crisis in Turkey. Without it, we would have been going into the first election without a sense of exchange rate stability. That is not good for any incumbent, least of all one that has been in charge for 16 years.

Second, the taper tantrum started about five years ago, yet Turkey has doubled its foreign currency debt since then. More specifically, under taper tantrum conditions, Turkey, China and Argentina have continued to increase their foreign currency debt. There was more risk in Turkey and Argentina, so the increase in their debt was higher compared to that of China.

Third, Turkey and China accumulated private sector debt in foreign currency, while Argentina accumulated public debt. Dealing with public sector debt is easier than dealing with private sector debt. Good for Argentina, bad for Turkey and China.

Fourth, China is a totally different animal from Turkey. Aside from being an economic and political behemoth, China has a current account surplus while Turkey has a higher, and rising current account deficit. Makes things easier for China and harder for Turkey.

Fifth, the short term debt to GDP ratio is also significantly higher in Turkey when compared to China. Take a look at the figure below. The greater the balloon, the higher the short term debt to GDP ratio. Look how much larger the Turkish balloon is compared to the Chinese one.

It’s very bad timing to have problems like these. With the global move from quantitative easing (QE) to quantitative tightening (QT), highly indebted countries in foreign currency need to move from leveraging to deleveraging. If you can not print dollars, you need to find a way to lower your debt.

Countries that can’t do this immediately stand out. Everybody is now wondering how Turkey will deleverage in an orderly fashion. Is it going to have a hard landing or a soft landing? That’s why a simple rate hike is not enough for the lira to stabilize, even in the short term. Turkey needs a stabilization package, with or without the IMF. Just have a look at how Argentinian peso is stabilized now.

These are the facts. Any government that fights them is bound to lose.

9haziran2018