Turkey nears ‘pariah’ status over defiance on rates

Turkish inflation figures released on Friday are likely to provide a reminder why investors were so stunned when the country’s central bank left interest rates on hold last week. Economists predict that inflation accelerated to more than 16 per cent in July, a reading that risks putting more pressure on a currency which is already the second-worst performer among emerging markets this year. And while Donald Trump’s threat that the US will impose “large sanctions” over Turkey’s prosecution of an American pastor is a new headwind for the lira, investors and analysts say the currency’s ailments are both longstanding and more fundamental. Foreign investors were pulling money from Turkish bonds and equities before the surprise decision from the Central Bank of Turkey to hold rates at 17.75 per cent, which gave the world the first chance to gauge the bank’s independence since the re-election last month of Recep Tayyip Erdogan as president. Given Turkey’s current-account deficit, many predict that the central bank will be forced to repeat May’s emergency rate rise. “Past experience suggests that the CBRT will ultimately be forced into an emergency rate hike,” said Jason Tuvey, senior emerging market economist at Capital Economics.

It is a prediction that finds support in an analysis of outflows from Turkey. Since February, foreign portfolio investors have withdrawn a net $4.7bn, the bulk from debt securities, according to central bank data. Even on the equity side, the 180 EM funds tracked by Copley Fund Research, a consultancy, have cut their average exposure to Turkey to just 1.42 per cent, the lowest figure since its records began in 2011. Almost a quarter of funds are now shunning Turkey completely. Factoring in market losses and the deteriorating exchange rate, non-residents’ ownership of Turkish equities, government bonds and corporate debt has plummeted from a cycle high of $92bn in August 2017 to just $53bn as of July 13, according to central bank data. Timothy Ash, sovereign strategist at BlueBay Asset Management, points out that it is a trend that leaves overseas investors covering a much smaller share of Turkey’s current account deficit. Between January and May 2017, foreign portfolio investors funded $13.2bn of Turkey’s $17.5bn current account deficit, according to the latest available data. During the same period this year they plugged just $763m of a swollen $27.3bn deficit. While emergency monetary tightening provided some temporary respite for the lira in May — and the currency remains off its record low touched earlier this month — some harbour doubts over whether it will work a second time round. Brad Bechtel, global head of foreign exchange at Jefferies, the US investment bank, said the central bank’s decision to hold rates had left Turkey as “the pariah of emerging markets”.

The alternative route for Ankara to win back market acceptance is through a messy economic adjustment, analysts say. Although economic growth was a healthy 7.4 per cent year on year in the first quarter, the central bank alluded to slowing growth, as well as the lagged behind effect of past rate rises, when explaining its decision last week. “The survey evidence points to an abrupt economic slowdown,” said Mr Tuvey, who is forecasting “a quarter or two of negative growth this year”, which should at least act as a drag on both inflation and the current account deficit, which hit 5.5 per cent of GDP last year, even before the more recent deterioration. Berat Albayrak, the new Treasury and finance minister, said last week that fiscal policy would make the “maximum” contribution to the government’s efforts to rein in inflation. Although Mr Albayrak’s family ties to the president — he is Mr Erdogan’s son-in-law — have left investors sceptical, the comment raises the possibility that Ankara will at the very least reverse the loosening of fiscal policy enacted before last year’s constitutional referendum and last month’s presidential vote. “If the CBRT is not prepared to tighten, then the ministry of finance will have to do the heavy lifting,” said Mr Ash. Mr Tuvey noted this “would certainly take some steam out of domestic demand and reduce price pressures”, as well as narrowing the current account deficit.

It would also return Turkey to the model long favoured by the business elite and their political allies: loose monetary policy to hold down borrowing costs, but tight fiscal policy to keep inflation in check, with the primary budget balance being in surplus for 12 of the past 15 years. Ankara may need to move quickly to reassure investors, however. The 10-year government bond yield jumped 167bp to a record high of 17.87 per cent on Tuesday while the BIST 100 equity index has fallen 24 per cent since January. The lira has fallen 3 per cent to a fresh record low of TL4.885 to the dollar since the rate decision, taking its year-to-date losses to 22.5 per cent. Further lira weakness “would put immense pressure on corporate and bank balance sheets”, noted Inan Demir, senior emerging market economist at Nomura. If Turkey’s foreign creditors became jittery as to health of the private sector’s balance sheet, Turkey “would be pushed dangerously close to a full-blown balance of payments crisis”.


Source : www.ft.com

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