2017 Turkish Lira Outlook

The Turkish lira has had quite a rough ride in 2016 and this year may be just as tumultuous. It was the second worst-performing currency of last year, dragged down by political woes, a struggling economy, and rising oil prices. Not even the central bank’s interest rate hike in December was enough to shore up the lira, which plunged to a record low of 3.5840 to the US dollar then.

It doesn’t help that a string of attacks has further dampened investor sentiment in the country. In late December, the Russian ambassador was assassinated in an art gallery in Ankara while New Year’s Day was marred by a mass shooting in an Istanbul nightclub. Emerging market currencies have been on the back foot over the holidays as well, dragged by reports highlighting massive capital outflows from China.

Weak growth, rate hike?

Analysts project that the lira may see further depreciation in the coming months, quite possibly breaching the lows back in December. According to strategist at Brown Brothers Harriman Win Thin, new lows may be seen on account of investor disappointment with the central bank’s latest decision, which was in defiance of Turkish President Erdogan’s recommendations. After all, hiking interest rates may hurt lending and spending, something that the economy desperately needs to thrive.

In the third quarter of 2016, the Turkish economy shrank for the first time in seven years, as the country felt the impact of the failed coup earlier in the year. Political instability has sent investors scuttling to move their funds elsewhere, causing GDP to sink by 1.8% during the period. Following the coup, President Erdogan ordered the arrest or detention of more than 100,000 civil servants and has seized more than 600 businesses on suspected links to Fethullah Gullen.

The shockwaves of this coup are far from over as another quarterly contraction is expected for the last quarter of 2016, thereby sending the lira on another wave lower. The lira’s depreciation has exposed the country to a rapid deterioration in its current account deficit, especially as the US Federal Reserve decided to hike interest rates back in December. This leaves Turkey with larger external financing requirements and corporate debt of more than $200 billion in foreign currency.

So far, government and central bank efforts have been failing to do the trick, as markets are able to sense the desperation. President Erdogan has told Turks to buy liras or gold while calling on the central bank to refrain from tightening monetary policy. This goes to show how heavily bearish investors are feeling about the currency, leaving the path of least resistance to the downside as the US central bank mulls the possibility for a few more rate hikes for the rest of the year.

The Trump Effect

Another factor that may complicate matters for emerging currencies, including the Turkish lira, is Trump’s presidency. The president-elect will be sworn in later this month and his rhetoric, particularly when it comes to renegotiating trade deals, may have a significant impact on emerging markets. The Donald has already leaned towards protectionism, which may mean lower trade activity for other nations that have relied on US funding and a free trade environment.

This week, a main risk factor for the lira may be the upcoming US jobs release, which may to show more or less the same pace of jobs growth as in November. Recall that a 178K gain in hiring was enough to convince the Fed to hike interest rates the following month so a potentially stronger than expected read may remind investors that three tightening moves may still on the horizon.

Credit Downgrade

Perhaps the nail in the lira’s coffin is the recent credit downgrade by Moody’s, which followed similar action by S&P and is seen as a preview of how Fitch might revise their outlook early this year. This downgrade has made it even more difficult for Turkish banks to operate, as the country’s biggest lenders had no choice but to accept higher funding costs for loans.

To make things worse, Moody’s threw the spotlight on the banking sector’s reliance on wholesale markets, which makes it difficult for banks to cover loans with deposits. In turn, this may require stronger loss absorption among financial institutions for banks to maintain current ratings – something that may be quite a stretch to achieve given the outlook for the Turkish economy.

Moody’s also downgraded its growth outlook for the country to an average of 2.7% which is less than half the average 5.5% growth from 2010 to 2014. Even the Turkish government revised its growth outlook from 4.5% to 3.2% for 2016. Apart from political troubles and banking sector woes, the Turkish lira’s depreciation is starting to translate to sharp gains in prices that could be a pain for consumers.

Inflation Outlook

A weaker local currency puts upside pressure on domestic price levels as importers would have to pay more units in order to buy the same products as before. These costs are then passed on to consumers who may maintain their spending habits if wage growth keeps up. If not, discretionary spending may take a hit and further dampen growth prospects.

According to Turkish central bank governor Murat Cetinkaya, the volatility of the lira may translate to inflation gains in the first part of this year. The impact of this on economic performance hinges on domestic demand so policymakers are still waiting to see which factors dominate in the medium-term. Furthermore, the central bank plans to keep close tabs on inflation to see if they might need to make more policy adjustments.

Global factors, which include the OPEC’s deal to curb oil production for the next six months, are likely to factor in as well. Higher crude oil prices may then translate to higher transportation costs, which may also put upward pressure on prices of goods. This may prompt yet another hike from the Turkish central bank, although it remains to be seen whether it would be enough to put a floor on the lira.

https://www.bloomberg.com/news/articles/2016-10-20/turkey-central-bank-unexpectedly-holds-three-main-interest-rates

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