Why Global Investors Can’t Ignore Turkey’s Recent Currency Issues


Investors outside Turkey will have to watch the currency’s recent plunge to all-time lows against the US dollar as the country burns its foreign exchange reserves, analysts said.

One US dollar brought in up to 7.37 lira USDTRY,
+ 0.26%
According to FactSet, a record low for the Turkish currency against the greenback on Friday. The lira has since rallied from the low, trading near 7.20 against the dollar in its most recent session. The dollar is up more than 21% against the currency for the year to date.

The lira decline comes despite the country spending billions to prop up the currency amid fears that weakness would fuel inflationary pressures. The country’s central bank was reluctant to raise interest rates to defend the currency. Turkish President Recep Tayyip Erdogan harshly criticized high interest rates and confused economists by insisting that high interest rates fuel inflation.

This week it appeared that authorities had made a policy change and eased some of the lira restrictions put in place in June and July so foreign banks could resume lira swaps, economists at Oxford Economics wrote. The steps came after overnight lira rates briefly rose to 1,000% earlier this week as a sign of market distress. The analysts noted that the central bank has also withdrawn measures to support liquidity.

“These are welcome signs that the authorities are now more likely to tolerate” [lira] Volatility they are not a valid substitute for the tighter monetary policy needed to restore confidence, ”they said.

In the meantime, the country’s foreign exchange reserves are clearly depleted. Turkey’s import coverage ratio was 2.8 months at the end of July (based on Friday’s 46.7 billion note.

According to analysts at Pavilion Global Markets, the authorities have been able to maintain some stability by borrowing hard currencies from the large pool of foreign currency deposits at domestic banks. And with inflation falling to around 11.75% from more than 25% last October – a move partly due to the sharp drop in oil prices – Turkish residents have conveniently “lent” their deposits to the central bank, they said .

That could change, however, as a rapid decline in the currency could further fuel inflation, the analysts noted, and risk a bank run if economic conditions continue to deteriorate and confidence in the central bank’s ability to return the borrowed currency suffers .

Turkey’s lenders should be careful, they said, noting that the country’s banks and corporations will have to roll over $ 100 billion in debt over the next 12 months, with net external debt standing at around $ 76 billion and be accompanied by “significant currency mismatches” between borrowers.

As an example, they note that, according to the Bank for International Settlements, Turkish banks have $ 29 billion in liabilities denominated in US dollars, compared with just $ 18 billion in assets. You also have more than $ 4.6 billion underfunding between euro-denominated assets and liabilities. It is even worse for the non-banking sector, where borrowers have 19 billion euros in liabilities and only 3.6 billion euros in assets.

“The risk is that large currency mismatches, along with an exploding current account deficit and a weaker currency, will hamper the ability of companies to service their foreign currency debt,” the analysts wrote. “Spanish, Italian and French banks have the largest claims on Turkish banks and subsidiaries. In order not to beat, UK banks have more than $ 18 billion in loan guarantees outstanding. “

Elsewhere, the analysts found that Turkey’s weight in the emerging market share indices has decreased significantly and is now only 0.35% in the MSCI Emerging Markets Index 891800.
tracked by the popular EEM ETF EEM,
compared to around 1.05% in January 2018.

“At first glance, this suggests that the direct impact of a sell-off in Turkish assets on the broader EM stock complex should be limited. But even if Turkish stocks had a weight of 1% in the index, the correlation coefficient rose to 0.8, ”they stated.

But they are more concerned about emerging market bond indices in local currency, in which Turkey has a weighting of 4.4%.

“Problems in one poorly managed emerging market usually indicate weakness in others and South Africa is spot on,” they said, noting a 19% decline in foreign South African bond holdings year-to-date, along with a decline in USDZAR rand.

This perhaps explains the concerns of overseas investors about sticking their toes back into emerging market bonds, they said, advising investors to look for correlations with Brazilian bonds, as these have the largest weighting in emerging market bond indices and are used as a proxy for the broader emerging market complex.