bne IntelliNews – Worries that Turkey could face another currency crisis “escalate”, says Capital

Fears that Turkey could face another currency crisis continue to intensify, Capital Economics said on November 16, with the sharp depreciation of the Turkish lira in recent weeks showing little sign of slowing down.

“The currency broke through the psychologically important 10 / $ level at the end of last week and has fallen further in recent days to 10.2 / $, bringing its total losses against the dollar since early September to more than 18%. It is by far the worst performing major currency in emerging markets this year, ”Capital’s Jason Tuvey advised investors in an analysis of the situation.

There is a growing risk that the Turkish central bank’s “continued obedience” to pressure from President Recep Tayyip Erdogan for a cut in interest rates will result in a sharp and disorderly fall of the Turkish Lira (TRY) over the years. coming days and weeks, causing inflation to increase. even wider and tighter financial conditions to be tightened, Tuvey wrote. “Stresses would build up in the banking sector as well, and while it would take a prolonged episode of market stress before a wave of bank defaults became a serious threat, a credit crunch would almost certainly follow.” , he added.

One of the most vulnerable

Turkey’s large short-term external debt and low foreign exchange reserves make it one of the emerging markets most vulnerable to tighter external financing conditions.

Turkish lira (against inverted $). Graphic: Capital economics.

Tuvey argued that perhaps the greatest threat to Turkey’s economic state is that a sharp tightening in external financing conditions makes it more difficult for banks to refinance their large short-term external debts, which are amount to $ 84 billion, or nearly 10% of GDP. .

“Of course,” he added, “banks have gone through periods of market turmoil in the past. For example, banks have secured wholesale funding at the height of market pressures induced by the crisis. pandemic last year.And when borrowing costs became prohibitive during the 2018 currency crisis [in Turkey], banks took their foreign currency assets held at the central bank as reserve requirements to meet external debt repayments.

“Banks have rebuilt their foreign exchange reserves over the past year and, in the event of a period of stress in the financial markets, they could once again withdraw their currencies held at the CBRT. [Central Bank of the Republic of Turkey] ($ 27 billion) and / or their foreign currency liquidity ($ 8 billion). The CBRT could also reduce the foreign exchange reserve requirement ratios to free up foreign exchange. The result is that banks might fend for a short period of time like in 2018, but they might struggle to cope if access to international capital markets were to be restricted for a considerable period of time. Even if this were avoided, bank balance sheets would likely contract and credit conditions would tighten.

First line of defense

A first line of defense to read it could be a new turn towards policies of squeezing imports and controlling capital, Tuvey suggested. “While we doubt that such policies will prove to be effective, policymakers have resorted to such policies in the past, including significant increases in import tariffs as well as instructions to banks to restrict the liquidity of the economy. delivers to foreign investors, ”he said.

“Failure to act in a timely and orthodox fashion to address investor concerns, however, risks creating a self-fulfilling cycle in which CBRT’s reluctance to tighten policy results in a further sale of Turkish assets (including including the lira), rising inflation expectations and growing demand for higher interest rates, the result is that the lira is weakening at an ever-increasing rate.

“The experience of 2018 is that the currency could experience intra-day declines of more than 10%, which, based on the current exchange rate, could cause the lira to drop well beyond 11 / $.”

The TRY has lost 27% against the USD in the year to date. The central bank is expected to cut its key rate to 15%, from 16% on November 18, after falling 300bp in its last two Monetary Policy Committee (MPC) meetings, arguing that inflationary pressure is temporary.

“The weakening of the pound is exacerbated by the current economic mismanagement, driven by the consolidation of the power of President Erdogan,” said Dennis Shen, director of the sovereign and public sector at Scope Ratings, as quoted by Reuters on November 16.

The massive sell-off “is a serious problem” given the private sector’s $ 124 billion net foreign exchange liabilities and 58% of the government’s foreign debt outstanding – “a share that continues to rise as the currency depreciates, ”he added.

The pound’s woes over the past week have been compounded by the strengthening of the dollar after higher-than-expected US inflation data.