Turkey’s lira weakens after Erdogan wins
Traders call for more orthodox fiscal policy
Turkey’s lira weakened after Recep Tayyip Erdogan won a presidential runoff election on Sunday, extending his time as the nation’s longest-serving leader in a tenure that has increasingly alienated foreign investors.
Stocks rose and dollar bonds were mixed at the open as investors awaited appointment of a new economic team that he promised would have “international credibility,” hinting at a potential turn away from an unorthodox policy mix based on ultra-low interest rates and heavy state intervention in markets.
The lira dropped 0.4% to 20.05 per US dollar, near a record low, as of 10:15 am yesterday in Istanbul. Wall Street analysts see more weakness ahead, with Morgan Stanley warning it may slide 29% toward 28 per dollar by the end of the year should Erdogan decline to change course. Wells Fargo & Co expects the currency to hit 23 by the end of the quarter.
“An Erdogan win offers no comfort for any foreign investor,” said Hasnain Malik, a strategist at Tellimer in Dubai. “With very high inflation, very low interest rates, and no net foreign reserves, a painful crisis affecting all assets could be on the way.”
Erdogan easily won in the second round with 52% of the vote, according to the unofficial count, and by shortly after 8 pm on Sunday he was delivering a victory speech to a throng of supporters from the top of a bus in Istanbul. Already in power for 20 years, the win gives him another five-year term.
Erdogan’s unorthodox approach to interest rates — he believes lower rates lead to lower inflation — has left markets beholden to an unpredictable mix of ad-hoc regulations and interventions, with new measures introduced informally and on a near-daily basis. They’ve also sent investors fleeing, with total foreign holdings of Turkish stocks and bonds decreasing by about 85%, or nearly $130 billion, since 2013.
“It’s obvious that the current economy model doesn’t work,” said Burak Cetinceker, a money manager at Strateji Portfoy in Istanbul. “Erdogan is probably also aware of that, and a modest transition to an orthodox policy in the near future is likely because otherwise, it is not sustainable. Any signal toward this would be welcomed by the market.”
The policies have also been expensive, with the central bank spending nearly $200 billion over the past year and a half to prop up the lira, net foreign-exchange reserves turning negative, and inflation soaring above 80% last year before falling to 44% in April.
Traders are more bearish than ever on the Turkish currency, betting that market forces will eventually overwhelm government controls. The extra cost to protect against lira declines in the coming six months — versus hedging against gains — rose to a record 21.4 percentage points yesterday, doubling from 10.7 in January, according to risk reversals.
In the equities market, Turkey’s benchmark index BIST-100 rose as much as 3.2% yesterday, with state companies, including Turkish Airlines and Aselsan Elektronik Sanayi, leading the gains. The index was trading 2% higher as of 10:06 am local time.
The first signs of any revision to the current policy mix is likely to come with appointments to key economic positions, including the Ministry of Treasury and Finance, and to the central bank. All of the current ministers won seats in parliament two weeks ago, which they would have to relinquish if they were to be reappointed to a cabinet position.
The weaker-than-expected effort by the opposition in the first round of the elections on May 14 led to a steep surge in credit-default swaps, a more than 20% slump in banking stocks and a retreat in the Turkish currency.
“Some corrections have to be made to avoid running out of FX reserves at least,” said Viktor Szabo, an investment director at Abrdn in London. Policy announcements will be awaited, because “the current heterodox policies are unsustainable.”