The sanctions imposed by the United States have exacerbated the Turkish macroeconomic crisis, with the country facing a heavy currency devaluation with consequent inflationary pressures. Our opinion on Turkey has been negative since the beginning of the year: that is, when the lack of intervention by the Central Bank of the Republic of Turkey (CBRT), in the face of the overheating of the economy fueled by debt, began to exert downward pressure on the Turkish lira and associated assets.
At the end of January, the Turkish lira was trading at 3,75 against the dollar, while inflation stood at 10,35%: more than double the long-term target of 5% set by the Central Bank. Higher oil prices have exacerbated inflationary pressures and the current account deficit. CPI inflation now stands at 15% and PPI at 25%, while 10-year sovereign yields hit 20% for the first time.
The lira has now depreciated by around 40% against the US dollar, standing (at the time of writing) around 5,3. Over the coming months, current trends are likely to see the lira become the worst performing emerging market currency year-to-date.
This latest bout of negative sentiment is partly due to the CBRT's reluctance to engage in continued monetary tightening under Erdogan's watchful eye. Last week's comments by Finance Minister Albayrak indeed seemed to confirm the interest rate restraint programme.
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Matters came to a head last week when the US imposed sanctions against two Turkish ministers, in retaliation for the detention of a US pastor. While recent news indicates that an agreement is imminent, the situation remains unstable.
External help now appears to be needed, which could come in the form of support from the IMF, but this would require a substantial shift towards more sustainable policies. The prospect of capital controls now appears to be a real possibility.
Investment Consequences
- We expect that continued inactivity could continue to put downward pressure on the Turkish lira and associated assets.
- The turbulent nature of events is causing Turkish assets to underperform other emerging markets.
- The Turkish financial sector appears particularly vulnerable in light of the looming need for refinancing and the large foreign currency liabilities of Turkish companies.
- We believe Turkey should turn to the IMF or seek other external support. Otherwise, capital control measures appear to be the only option.
