Double jeopardy in Turkey
I feel bad for Dr. Erdem Başçı, the governor of the Central Bank of Turkey. Just at the end of August, he surprised me by saying that the “Turkish Lira could reach 1.92 against at the end of December 2013”, hinting a surprise move. Those months passed rather swiftly, and here we are at the last third of December. The end of the year is approaching and the Lira is now around 9% lower than the nominal Başçı limit. It is around 2.09 at the time of writing. Never set a nominal limit for the exchange rate. It is bad for the already tarnished credibility of the Central Bank. Some stability would not have gone remiss in these very interesting times.
There is no question that the Turkish Lira is under severe stress. It is breaking its own records of depreciation. One day after the start of the long-awaited tapering of the Federal Reserve, the rate of depreciation was around 3%. But why all the stress? I see three reasons. The first is a technical issue, I’m afraid. It is the Central Bank’s volatility-lowering, liquidity-enhancing policy line. That is done by selling dollars to the market, which enhances the liquidity of the market and prevents the exchange rate from floating. That makes an exit more costly to portfolio managers. So the liquidity-enhancing policy of the bank is just one major reason.
The second reason is Turkey’s high current account deficits. We have the fifth largest such deficit in the world in dollar terms - the US being the first. So we are already at risk. Around 60% of our foreign funding is short term. That piles on even more risk. Now this coincides with the first reason. With the start in tapering, portfolio managers are trying to reshuffle their portfolios towards home assets. What is the best way to do that? Just focus on countries with more liquid markets. Why? You can exit with less damage to your portfolio value. More liquid means asset markets with lower price volatility. What is the Central Bank of Turkey trying to do now? Just that! So what is the end result? In countries with lower price and exchange rate volatility, there is a higher volume of exits. Turkey, with its more than a $100 billion--a-year current account deficit, is expected to face the highest volume of exit. Again – that is simply because it is doable with the lowest losses. That is thanks again to the Turkish central bank, I have to say. But by all means, increasing the volume of the dollar at auctions is rather helpful for “the foreign component of the interest rate lobby!” I find it rather funny, I have to confess.
The third reason is Turkey’s increasing vulnerability due to the graft probe that started just before the Fed’s decision. And it isn’t only the probe itself, but all the rather outrageous allegations involving bribery and money laundering, too. Just look at dollars flying around. Then look at the government’s first reaction to the developing court case. Saying that there is “a state within the state” is not helpful for near term political stability in the country. No analyst can be sure where this process will lead. It is the first of its kind, which makes it hard to analyze.
Let me give you the formula for destruction: Tapering, for the first time, is a source of economic instability. The graft probe and the government’s initial reaction to it are also unprecedented. Double jeopardy for Turkey. Add to that a Central Bank that is helping the exit, and you put the lira under stress.