Since late 2010, the Central Bank of Turkey has been employing unconventional monetary policy tools primarily for price stability, and creating an environment conducive for economic development. It is hard to tell the reserve bank has succeeded in the former, and Turkey’s track record of economic growth is disputable.
Now with the CPI growth standing at the highest levels since the inflation targeting implied and fiscal policy being eased to spur the growth which has been rarely observed during the AK governments that are known for the determination to keep the public debt/GDP ratio at the low levels, it is time to look back and see how we ended up here. Please take a moment to look at the chart below.
Also note that the CBT’s average cost of funding hit its highest point at 11.96% last Friday (5/5/2017) since the the global financial crisis period.
Having lived up to all the hype, Turkey’s February headline inflation printed a double-digit figure. Moreover, further upside movement should be expected as core indicators, the negative base effect of food prices, and most importantly, producer price index that is hanging around its record highs in a decade. Indeed, Turkey’s PPI hit 15.4% in February, which is the highest figure posted since July 2008, signaled some pressure to be felt arising out of cost channels.
Our long-term trend for the core indicator D-index suggests that it may already have reached at the end of upward trend, while we see it fit to add annotation due to above-mentioned factor that are able to lift the inflation unfavorably.
That said, Turkish central bank, at the peak of its well-known unorthodoxy, keeps the effective funding rate above the 12-month forward inflation expectations, as it is currently throwing money around with a cost almost 250 bps above its policy rate. We expect the bank to maintain its policy, and lift its marginal funding rate by another 100 bps in the upcoming monetary policy committee, which is scheduled to the day after the US Federal Reserve FOMC where another 25 bps could be added to the cost of global reserve currency.
Meanwhile Turkish lira’s performance has absolutely failed to paint a promising picture.
Declining volumes in currency trading has been an overriding theme as banks have been subject to stricter regulations on their trading activities. It is early to talk about the recent Trumpflation trade has caused any change globally, but when it comes to trading Turkish lira we still see that shrinking volume is an underlying trend.
Below we present the chart that shows total annual TRY trading volumes in form of forwards, spot trading and swaps.
Clearly 2013 was a turning point when uncertainties around emerging economies started to loom, leading stronger corporate demand for forwards to the end that hedge their FX risks. That period also marked the banks losing interest in TRY spot market. More importantly, we saw a huge drop in swap volume which is consistent with our voluntary deleveraging theory which simply based on Turkish banks’ weaker demand for foreign financing given the extremely high loans-to-deposits ratio (In Turkey banks have increased their foreign borrowings to finance the lending growth due to weakness in deposits, used swaps to hedge those positions). We believe that this credit positive, growth negative.
We note that spot trading volume of TRY declining roughly 14% y/y is worrisome that the currency is now more exposed to liquidity risk. As reported in some media outlets, global investment banks are now kind of through with TRY market. We expect TRY to remain volatile for some time come, which could partly offset by rate hike by the central bank. Our prospect is for a 2017E 10% policy rate and we recommend investors to consider 1-year xccy swaps afterwards.