Turkey approaching a hard landing. Turkish inflation is currently running above 15%, a 15-year high, and the effective bank rate is 20.75%. Despite this positive real rate of more than 5 percentage points, the currency continues to weaken and the current account deficit continues to widen. Fundamentally, since the GFC Turkish corporates have become too reliant on overseas funding, which was a lot cheaper than borrowing at home. The overhang of FX debt means there is a persistent domestic bid for USD to cover debt-servicing costs.
Erdogan has appointed his son-in-law as the new economy minister and has effectively ended the central bank’s independence by scrapping the minimum term for its governor and claiming the exclusive power to appoint central bank policymakers. As such, Erdogan, who is on record as saying high interest rates are the cause of high inflation, is likely to exercise more influence on monetary policy. His election victory is unlikely to lead to a more orthodox economic policy in Turkey.
Hard currency debt means further TRY weakness. From a valuation and carry perspective, TRY looks attractive. It is one of the cheapest currencies in the world and offers carry gains of 18% a year. Bouts of currency weakness may be interspersed with periods of consolidation as speculative investors attempt to pick up a few percentage points of carry. But the lira’s weakness is now being driven by domestic corporates. Bloomberg puts the foreign asset/liability mismatch at $221bn at the end of April; non-financial FX debt is more than twice Turkey’s FX reserves. We downgrade TRY from 0 to -1.
Our Asset Allocation calls have a 3-6 month time horizon. TRY/USD was at 0.21 when we published this piece and fell 29% to a low of 0.15 on 3 September 2018. A huge rate hike of 625bps to 2400bps on 13 September 2018 has so far only stablised the TRY/USD at 0.17.