13 August 2018
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Turkey’s currency experience on Friday – its worst one-day performance against the dollar since February 2001 – signals deep-rooted monetary and fiscal challenges that require significant policy change, according to the views of managers overseeing investments in the country.
Emre Akcakmak, portfolio manager at Swedish manager East Capital, said in a note that the currency moves cannot be explained by economic fundamentals alone, but rather that “investors seem to have thrown in the towel in their hope for a clear and a decisive central bank monetary policy”, while “the quarrel between Turkey and the US over judicial matters and an eventual announcement of US sanctions on two Turkish ministers fuelled concerns about Turkey’s external financing requirements”.
The economic challenge is pretty clear, Akcakmak suggests: “The weaker lira will have a deeper impact on the economy. Inflation will climb further which calls for decisive action by the central bank. Higher interest rates are likely to create more trouble for the companies and give less room for long term capital investments. Consumer confidence will be hit and unemployment will increase as the economy slows down.”
Akcakmak is clear that the government must consider policy change that allows the central bank to tackle inflation rising towards the high teens, but more than that “the leaders of the country should probably be more conscious of their rhetoric. Neither foreign nor local investors welcome the ‘populistic rhetoric but pragmatic action’ equation, especially when the action diverges away from being pragmatic as far as economic policies are concerned.”
On Twitter, Akcakmak noted that accepting help from the IMF is unlikely because “Erdogan hates the IMF”, but also that the type of help required is still not certain because unlike other countries with foreign exchange challenges, such as Argentina, a lot of the FX debt is private in Turkey, meaning it is not immediately clear to what extent there is “damage”.
The East Capital Turkiet feeder fund available in the Swedish market registered a decline of close to -38% year to date to 9 August in SEK terms.
Delphine Arrighi, fund manager of the Old Mutual Emerging Market Debt fund at Old Mutual Global Investors, similarly notes that “we doubt the political will is there in Turkey” to make decisions such as calling in the IMF or adopting capital controls – which Arrighi sees as more likely – while “more pain might be needed to force policy action.”
“Some resolution of the political spat with the US could lead to some near-term relief in the currency, but this is unlikely to be sustainable if not accompanied by credible economic actions.”
Damien Buchet, head of total return strategy at Finisterre Capital, said that “Turkish assets are becoming increasingly difficult to trade in this environment.”
“I still favour being long credit default swaps with a bias towards further curve inversion, as foreign banks may increasingly buy short term protection, while active investors may take profit on liquid long 5Y CDS positions at some point. I would still steer clear of lira shorts due to the risk of more supportive action – liquidity or rate hikes, or both – but the potential for volatility in either direction seems to be increasing. If we do end up with some private sector defaults or bank stresses, leading to the state recapitalising its banking sector, the sovereign external debt and long-dated Turkish lira-denominated debt would be a screaming buy – but we remain a long way off that stage yet, and that would likely require some extra help from outside sources, from the IMF or otherwise.”
Miles Eakers, chief market analyst at Centtrip, sees the lira falling to 10 to the dollar unless there is a rise in Turkish interest rates.
And Edouard Senechal, senior analyst for William Blair’s Dynamic Allocation Strategies team, characterises developments as Turkey playing “a game of chicken”.
“Presently, Erdogan remains backed into a corner, from which he must attempt to emerge without losing face. To a populist leader, like president Erdogan, appearances are often more important than facts. Therefore, we believe the most likely outcome is that Turkey will negotiate behind the scenes with the US to find a solution and slowly de-escalate the situation while maintaining a high interest rate to attract foreign investors.”
