Fragility Ahead for Turkish Lira?
- October 12, 2016
- Oguz Erkol
Turkish lira has been particularly weak as of the beginning of October. As prospects of a Federal Reserve rate in December hike boosted again, many emerging market currencies is doomed to be weak in the remainder of this year. However, Turkish lira has seemed to be high-beta asset class in EMFX space so far.
Looking at the domestic factors that resulted in a weaker lira, Moody’s downgrade that deprived Turkey of IG is the primary reason in our view. Apart from that investors started to pay attention to Turkish corporate sector that holds a big chunk of debt in hard currencies.
After consecutive rate cuts, Turkish central bank went for lowering rates for require reserve maintained in terms of FX in an attempt to increase liquidity to boost the economic activity. This has caused a decline in the bank’s gross reserves account, placing downward pressure on lira.
The chart above shows Turkey’s gross FX reserves in months of imports where exports are calculated by taking the average of 12-month trailing total imports. Apparently, Turkey’s pocket has been deep enough to cover 4-7 months of imports for almost over the past two decades. 2016 also marked an improvement. That said, Turkey’s ability to meet the FX requirements is lower when compared to, let’s say, India, whose reserves are 10 times larger than its monthly imports.
Second, the rebound in global oil prices is starting to reserve the oil-price driven external adjustment. Coupled with the fall in tourism revenues, this is very likely to hurt lira in the upcoming period. Each $1 rise in oil price per barrel approximately adds $200 million in Turkey’s energy bill. It’s disputable whether the recent bullish oil market is driven by market forces, but a recovery in energy commodities enlarging Turkey’s current account deficit is not an element of surprise.
Lira weakness will also have consequences on the macroeconomic front including declining consumer confidence, accelerated inflation, and earnings recession for Turkish corporates owing to the high level of foreign debt. While we attach importance on domestic factors, it is still global market sentiment that drives EMFX markets.