An orderly decline
Turkey has a long history of rampant inflation and aggressive currency movements. The vulnerability of the lira was at the root of the Turkish financial crisis of 2001, after an unsustainable build-up in public debt, exacerbated by a negligible export industry and political turmoil. But now the lira, like so many other aspects of Turkey’s financial markets, shows signs of having come of age. Solomon Teague reports.
Before the global crisis hit Turkey in late 2008, the lira had been gradually strengthening. But in the six months from September 2008 to March 2009, the currency fell from 1.2 against the dollar to around 1.8 – a drop of 50%, and business as usual for one of the world’s more volatile currencies.
“Turkey had the highest interest rates in the investable world,” said Paul Biszko, senior emerging markets strategist at RBC Capital Markets. “It was a huge beneficiary of the carry trade, but that only holds up when volatility is low, otherwise the risk is too high.” As such, money has flowed out of Turkey in the last year, resulting in the plight of the currency. In all, Biszko estimated US$18bn flowed out of the country between May 2007 and March 2009.
Yet this slide must be seen in the context of a massive revaluation of emerging market risk generally. The lira is one of the more liquid currencies in the region, making it prone to bigger and more frequent moves than its smaller peers, said Biszko. The country is also vulnerable because of the high number of foreign investors active in its markets, making it an effective barometer of the mood of global investors in particular. While domestic investors tend to be more ‘sticky’, foreigners are quick to move money out of a country when turbulence hits, exacerbating price moves in assets and in the currency in which they are priced.
On the other hand, the lira represents a country with a strong banking system and a strong fiscal position, relative to its peers in Central and Eastern Europe. It also has low leverage – again, relative to CEE.
This crisis marks a coming of age for the currency. “In times of turbulence the lira used to be punished more than other currencies,” said Martin Blum, head of EEMEA economics, fixed income and FX research at UniCredit Group. “This time performance has been more representative, and it outperformed many currencies to the end of February, for example in Eastern Europe.”
A breakthrough in the IMF package would only strengthen the lira’s position (see separate story, "Helpful interference"). On the other hand, if the lira’s gradual decline turned into a rout and the government was forced to step in it could get very expensive, making the need for IMF money much more urgent.
As welcome as the lira’s new found stability is, it is unlikely the government would want to see it go a step further and actually appreciate against the dollar or the euro. Many are predicting that the government wants to see continued gradual weakening, and will help orchestrate this if necessary, to assist Turkey’s ailing exporters. A range of 1.35-1.45 against the dollar is probably ideal, said Blum.
Part of the lira’s weakness has been Turkish savers’ fondness for hard currencies. According to one estimate, 40% of Turkish deposits are in hard currencies – higher than found in much of Europe. The holding of gold, in particular, is more widespread in Turkey than in Europe: it is a traditional wedding gift, being a long-term store of wealth – a hangover from the country’s inflation-savaged past.
There are signs that this is changing. “Currency risk in the banking system is very limited,” said a source at the Turkish Banks Association, pointing out that the share of foreign currency items in the sector's balance sheet stands at 15%. On the other hand, “considering that the private sector has indebtedness in foreign currency, there is a possibility that the loss of value in Turkish lira may be reflected as credit risk in banks through the real sector,” added the source. The current account deficit stands at approximately US$15bn, part of a broader external funding gap of US$60bn–$70bn.
And while Turkish banks may be well capitalised with deposits – with a relatively high proportion in dollars and euros – the majority is still in lira, meaning the country will feel poorer if the lira declines too far against foreign currencies.
So Turkey’s outlook hangs in the balance. “If we see a return of stability we will see Turkey outperform,” said Biszko. Interest rates are still high by international standards, while the Central Bank has a relatively hands-off attitude, which will attract foreign capital if global conditions allow. On the other hand, if the global crisis continues to promote volatility, Turkey will continue to suffer – along with all emerging markets.