Turkey’s lira intervention raises questions for investors
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After days of sustained declines for Turkey’s currency, the country’s policymakers stepped into action on Wednesday with measures that sent the lira up about 5 per cent.
However, with the currency down about a third this year and Turkey’s economic imbalances still unaddressed, investors are examining what exactly Turkish authorities did and whether it will be enough to stem a crisis that has bled into other emerging markets.
Reeling in the shorts
The single biggest effect came from a rule change to make it harder for speculators to “short” the lira — borrowing it to sell it for dollars or euros in the hope of buying it back later for less. Banks lend lira by means of currency swaps. On Wednesday, the Banking Regulation and Supervision Agency cut the value of the swaps banks may hold on their books to the equivalent of a quarter of their regulatory capital, down from a previous limit of 50 per cent set on Monday.
In effect, banks were forced to stop lending lira in this way and not renew any existing contracts. The cost to those borrowing the lira doubled between Monday and Wednesday, to an annualised interest rate of 35 per cent. Short-sellers retreated and the lira rose.
Alberto Gallo of Algebris Investments, a London-based hedge fund that has been bearish on Turkey, said while effective in the short term the measure risked making the corporate and banking sectors more vulnerable.
“Banks use swaps as a hedge against currency depreciation, for themselves and their clients,” he said. “This [move] is medium-term negative because they cannot buy protection, at a time when a hedge against further depreciation would make sense.”
Easing the pressure on banks
Regulators also provided some relief to banks from the impact of the lira’s depreciation on their capital ratios, and announced more flexible rules on loan restructurings.
The rules allow banks to use the exchange rate at the end of June to calculate capital ratios. Goldman Sachs analysts estimated that every 10 per cent depreciation in the lira knocked an average of 50 basis points off the capital ratios of the country’s banks because their high levels of foreign currency loans inflate the value of their assets relative to the value of their lira-based equity.
Investors have been worried that Turkish banks could need to raise more capital to cope with the currency crisis. The loosening of rules around loan restructurings comes ahead of an expected increase in defaults by Turkish borrowers, hit by the plunging currency, falling consumer confidence and economic disruption.
What about raising interest rates?
President Recep Tayyip Erdogan has long railed against high interest rates, calling them the “mother and father of all evil”. During a visit to London in May when he was expected to reassure investors, he instead told them that high rates caused inflation rather than cured it.
But officials at the CBRT, the central bank, may see things differently, even after the removal of the market-friendly Erdem Basci as governor in 2016.
The bank dashed investor expectations by failing to raise interest rates at its July policy meeting — a decision widely seen as the spark that ignited the current crisis. Its last increase in its official policy interest rate was in June, taking the one-week repo rate to 17.75 per cent.
But the bank also has overnight lending and borrowing rates set 1.5 percentage points either side of the repo rate, in a structure known as the interest rate corridor. This week, it has stopped lending at the repo rate and pushed banks to the higher rate of 19.25 per cent.
“For the past month the CBRT has been out to lunch,” said Timothy Ash of BlueBay Asset Management. “Now they have been told to do whatever it takes bar hiking the headline policy rate . . . So we are back to Basci, using an interest rate corridor again.”
The problem for the CBRT, analysts say, is that the corridor may be too narrow. Inflation is already running at 16 per cent and will be driven higher by the lira’s depreciation. This leaves the real, or inflation-adjusted, policy rate at little more than 2 per cent at the most, a low level by emerging market standards.
Will it all work?
Wednesday’s moves have restored a measure of credibility to Turkey’s policymakers. But the consensus among investors remains that the measures were not enough. There is also the unresolved tension between Turkey and the US.
Even were policy credibility and peace with the US to be restored, analysts and investors warn, Turkey would face serious challenges.
As analysts at JPMorgan noted on Wednesday: “Even if the current bout of lira weakness dissipates soon . . . the trade-offs have worsened as the developments of the last few months will likely have a lasting impact on Turkey’s ability to finance itself abroad.”
Turkey’s recent economic growth of 7 per cent a year led yield-hungry investors to turn a blind eye to its increasingly precarious exposure to foreign currency finance, analysts say. But with its fragilities exposed, and with $180bn of external debt maturing in the next year and a current account deficit of $50bn, Turkey will need more than short-term measures to restore confidence.
“It’s not about the currency under pressure,” said Viktor Szabó, senior investment manager at Aberdeen Standard Investments. “It’s more about slowing down credit growth domestically and slowing economic growth.”
Additional reporting by Andrew England and Laura Pitel
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