The lira: a brief history
We break down the course of events after the TRY/dollar reached a historic high of 4.93. What do markets expect?
We look at the life of the lira during last week’s turmoul. What do markets expect?
1 Depreciation of the Turkish lira
The TRY/dollar, which was at 4.00 at the beginning of the month, reached its historic high, exceeding 4.92, on May 23. Although global conditions in light of the Fed’s monetary tightening played a role, fundamental problems of the Turkish economy – the role of the Central Bank (CBRT) in particular - were also to blame for this turmoil.
2 No action from the CBRT
Under normal conditions, the CBRT should respond to devaluations in the currency by increasing interest rates, because a sharply devaluating Turkish lira would put stress on inflation. However, the CBRT has been hesitant to raise interest rates due to the fact that President Recep Tayyip Erdogan has often referred to high rates as “the mother of all evils.”
3 Previous examples
There was an interest increase pressure on the CBRT during the ‘taper tantrum’, after Fed Chairman Ben Bernanke’s speech in May 2013. At that time, the Central Bank, which increased its interest rates by acting proactively against external shocks, was accused of treason. In the following periods, the CBRT’s interest rate actions have always been behind the markets.
4 Extraordinary tools
The CBRT traditionally uses the 1-week repo rate to set policy. A few years ago, it added the overnight lending rate. This system, called the interest rate corridor, gave the Bank a chance to play against short-term shocks without holding a meeting. In the past year, the CBRT has started to use the late liquidity rate, which is higher than the overnight lending rate, and considered the upper ceiling, as the policy interest rate. The CBRT’s use of this interest has brought its policymaking into question.
5 Extraordinary meeting
The Monetary Policy Committee raised the late liquidity window rate from 13.5 percent to 16.5 percent. The Bank made the following statement: “The unhealthy price developments observed recently in the markets and the ongoing rise in inflation expectations have increased the risks of general pricing behavior. The Committee has decided to make a strong monetary tightening move in order to support price stability. The bank will continue to use all the instruments available for price stability. The tight stance on monetary policy will continue with determination until there is a significant improvement in the inflation outlook.”
6 Currency effect
Following the announcement, the TRY/dollar, which was in the 4.844.85 band, fell sharply to 4.55. However, after the announcement of the decision, the TRY/dollar rebounded to 4.63-4.64 and continued its rise over the following days to above 4.70.
7 Government’s reaction
Deputy Prime Minister for the Economy, Mehmet Simsek, made the following statement: “Turkey will not be obstinate with the market. We will not step back from a rule-based market economy. With a full support from the government the CBRT made a very strong move, this reaction will continue if necessary. Normalization and simplification of monetary policy will continue.”
8 What happened backstage?
Simsek, Finance Minister Naci Agbal and CBRT President Murat Cetinkaya held an extraordinary meeting on May 21 after the lira continued its decline, according to a Reuters report based on three sources close to the issue. At this meeting, it was agreed that interest rate hikes should be made to stop the rise in exchange rates. However, the CBRT did not want to act immediately due to the stance of President Erdogan. Prime Minister Yildirim told the President at their scheduled meeting on May 23 that the interest rate should be increased in order to stop the decline in the lira. The CBRT was able to increase rates only after Yildirim convinced Erdogan.
9 Foreigners still lack trust
UBS announced that it did not find the Turkish lira attractive despite the recent increase in interest rates. “Increasing oil prices will put further pressure on the current account deficit, which reached 6.7 percent of GDP. The decline in U.S. bond yields following the increase in interest rates in Turkey at the beginning of the 2014 and 2017 does not seem likely this time,” the bank stated. The bank also noted the foreign exchange trends of domestic investors. If domestic investors go for dollarization, the exchange rate may be under pressure, it said.
10 June 7 expectation
Rabobank Emerging Markets FX Strategist Piotr Matys stated that anticipation of another rate hike is high: “I think it is possible that the bank will increase interest rates again on June 7. Today’s move in the Turkish lira show that there is low confidence among investors. There may be more tightening to stabilize the TRY and show that the worst has passed.”