Turkish Lira’s Plunge Throws Institutional, Economic Challenges Into Sharp Focus
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Scope Ratings has ranked Turkey as among its “Risky-3” out of a sample of 63 economies most at risk of a balance of payments crisis, given the lira’s history of significant volatility and the high proportion of government and private sector debt denominated in foreign currencies.
The rating agency downgraded Turkey’s credit ratings to B+ from BB- on 10 July to reflect growing risks to external sector stability and deterioration in the governance framework including risks stemming from long-run foreign-exchange reserve depletion. The lira trades presently 33% below an August 2019 peak against the dollar. The Turkish currency also hit fresh all-time lows against the euro this past week, before making up some losses after evidence of policy tightening.
Early signs of reversal in the direction of policy tightening, but unlikely enough
Friday’s closure of the one-week repo financing window forces central bank funding of banks to the costlier overnight window – an effective 150bp hike. Next, regulators are expected to ease an unorthodox “asset ratio”, effective since 1 May, which has compelled lenders to raise lending activities unsustainably. Lira lending from the consolidated banking system rose 45.9% YoY as of July. The banking supervisor this week, moreover, announced easing of some rules that restrict foreign banks from access to lira liquidity, under strict conditions in regard to the use of such liquidity.
“So, we’ve now sort of returned to the 2018 lira crisis response playbook of backdoor rate hikes via shifting funding between central bank windows, to avoid unwanted attention for central bankers from President Recep Tayyip Erdoğan were policy rates themselves hiked, whilst, moreover, easing foreign exchange reserves deficits via funding from foreign sources like Qatar,” says Dennis Shen, lead analyst on Turkey at Scope. “Unfortunately, what ultimately eased the crisis in 2018 more tangibly was a return towards conventional policymaking and a significant hike in the policy rate itself.”
“In consideration of elevated inflation of 11.8% in July, Turkey’s real policy rates remain among the world’s lowest. However, a rate hike will not be straight-forward given politicisation of the central bank and interventions from the President, who has a stated preference for low rates. A significant rate hike would be helpful in stabilising current exchange rate devaluations; however, tightening would also come at some price to Turkey’s fledgling economic recovery.”