The Turkish Lira hits record lows on global slowdown worries, political uncertainty

Seltem Iyigun from Coface.

The Turkish lira plunged to fresh record lows against the dollar in August, hitting 3.0 before firming slightly as political uncertainty after the June elections, the central bank’s reluctance to increase interest rates and conflict in the southeast border weakened investor sentiment.

The slowdown in the Chinese economy and uncertainty related to the timing of the US FED rate hike also added to the lira’s depreciation, amid other emerging currencies weakness as well. The lira has lost around 20% of its value against the greenback so far this year, making it one of the worst performing emerging currencies.

The coalition talks have weakened investor sentiment. The ruling Justice and Development Party (AKP) won Turkey’s parliamentary election held on June 7, losing its single-party government held since 2002. AKP won 258 of parliament’s 550 seats, while the second-biggest Republican People’s Party (CHP) took 132 seats. Two other parties, the right-wing Nationalist Movement Party (MHP) and the pro-Kurdish People’s Democratic Party, each took 80 seats.

A new government had to be formed within 45 days of the mandate being given but talks between AKP, which had the mandate to form a government, and other parties failed. On August 24, a day after the deadline passed, President Erdogan formally called for a new election. The statement didn’t explicitly mention a precise date when the election would be held, but the president has previously cited 1st November 2015.

This political uncertainty has discouraged investors who were hoping the Islamist-rooted AKP would be able to form a coalition with the centre-left CHP and avoid a snap election. This has added to concerns of continued slow growth, high inflation (6.8% in July) and a wide current account deficit (estimated at 4.8% of GDP in 2015 despite slower growth).

Conflict in the southeast has added to the political uncertainty. More than a hundred people have been killed since July in renewed conflict between the outlawed Kurdistan Workers’ Party (PKK) and Turkish security forces.

In August, Turkey’s Central Bank kept its rates flat on easing inflationary pressures, whereas a rate hike was expected to support the lira. The bank kept its overnight lending and borrowing rates at 10.75% and 7.25%, respectively. It also left the one-week repo rate, its policy rate, at 7.5%.

Developments in the global economy also weakened the lira. The slowdown in the Chinese economy is causing problems to emerging markets, including Turkey, as it triggers fears about global growth. Additionally, the uncertainty related to the timing of the Fed rate hike also triggered outflows from riskier emerging assets.

Risks

Although the country will have snap elections, there is the possibility that the results will be unchanged. This may result in two consequences: It may increase further political uncertainty because leaders will not be able to form a coalition before, and secondly, the formation of a coalition with the same result. Some polls suggest AKP may have slightly increased its voter support, mainly due to the violence in the southeast region. This marginal increase in voter support may mathematically allow AKP to obtain enough seats in Parliament to form a single-party government.

If the lira’s depreciation persists and begins to impact on growth, this may push international credit rating agencies to reconsider Turkey’s sovereign rating currently standing at investment grade. The decision would result in a further depreciation of the lira.

Risks related to the central bank’s reluctance to increase rates are mitigated because monetary tightening may not be totally effective in reversing capital outflows. On the contrary, the central bank’s liquidity tightening and simplification in its monetary policy may be supportive of the lira once political tensions ease.

Further depreciation and volatility of the lira, due to the political uncertainty and global risk aversion, may further weaken the Turkish corporate sector. Turkey’s manufacturing industry remains dependent on energy and intermediate imports. Therefore, weakness in the lira will increase production costs and narrow profit margins causing corporates to delay payments and reduce the possibility of issuing foxex-denominated debt instruments.