Turkey will suffer second currency crisis in two years

Turkey may be facing its second currency crisis in as many years after the lira slumped to a record low against the dollar this week, Reuters reported on Wednesday.

A combination of interest rates below inflation, depleted foreign exchange reserves, easy credit and a sharp contraction in tourism revenues does not bode well for the lira, the news wire said.

Analysts are unsure what the fair value of the lira is, Reuters said. Meanwhile, Turkey’s central bank is constrained in its monetary policy choices by the aversion of President Recep Tayyip Erdogan to higher interest rates. Erdogan recently repeated his preference for lower rates and sacked and replaced the governor of the central bank last year for failing to cut them.

The provision of cheap credit, led by state-run banks, has brought a boom in borrowing by consumers and businesses and an increase in demand for imports, widening Turkey’s current account deficit. At the same time, the money needed to fund that deficit is in short supply as foreign investors sell lira assets and the tourism industry reels from the impact of COVID-19.

The Institute of International Finance (IIF) says the lira’s fair value lies at 7.5 per dollar, citing the current account. It revised its estimate from 6.3 per dollar in June and 5.5 in April, Reuters said.

The lira fell to a record low of 7.408 per dollar this week, taking losses for 2020 to almost 20 percent. It rose 0.8 percent to 7.3 agains the U.S. currency on Wednesday afternoon local time. 

“A severe credit crunch in the second half of 2018 put the country into recession, shifting the current account very rapidly from deficit to surplus,” said Robin Brooks, the IIF’s managing director. “We expect a similar dynamic now.”

Turkey’s real effective interest rate is almost the lowest in the world – the central bank’s benchmark lending rate is 8.25 percent while annual inflation stands at 11.8 percent, meaning real interest rates are deep in negative territory. That is prompting Turkish lira deposit holders and foreigners who invest in local bonds to sell up and buy foreign currency.

The central bank is due to meet on Thursday to decide on interest rates. Commerzbank does not expect a meaningful policy rethink unless the lira falls to levels nearer 8.5 per dollar, Reuters said.

The lira’s path is clear and no tinkering with the banking system or a partial introduction of capital controls can change things, the German bank said.

The lira may still have much further to fall, Reuters said, citing prices on the options market.