As international investors punish Turkey’s lira, the country has to consider its options to stop this currency crisis in its tracks.
So far this year, the lira USDTRY, -4.9938% has fallen more than 80%, suffering a slump of 16% on Friday alone. The dramatic selloff weighed on global markets and has shone a light Turkey’s mounting foreign currency-denominated debt burden, high inflation and unorthodox policies, all of which have dragged on the lira.
Check out: 3 reasons the selloff in Turkey’s lira matters for markets all over the world
Turkey’s options seem limited and urgent action is required, market participants said. But given the initial reaction from government officials to Friday’s lira slump, investors are unsure whether Turkey will take the decisive steps that markets desire.
Strategists see four ways out, and they’re given below.
Meanwhile, Turkish President Recep Tayyip Erdogan, who has been accusing the U.S. of engineering an economic war on his country, redirected his ire on Monday toward “economic terrorists on social media” who are disseminating alleged disinformation about the state of affairs.
1. Rate hikes
“The policy response needs to be a further hike in policy rates, more than 500 basis points, fiscal tightening of 1% to 2%, and measures to address concerns over bad debts in banks in sectors such as energy, real estate and construction,” said Tim Ash, emerging-markets senior sovereign strategist at BlueBay Asset Management, in emailed comments.
But Erdogan is vehemently against higher interest rates, having called them the mother of all evil. Ideally, the Central Bank of the Republic of Turkey wouldn’t be influenced by the president, but his words have taken on more power since he was re-elected in June following a constitutional referendum last year.
“President Erdogan made it clear on Saturday that he had no intention of allowing interest rates to rise, saying, ‘If we don’t minimize this interest rate, it is a vehicle of exploitation that will make the rich richer and the poor poorer.’ Sure enough, the one thing the central bank didn’t do ... was raise interest rates,” Simon Derrick, chief currency strategist at BNY Mellon.
Investors have long hoped for a stronger approach from the CBRT, which Monday said it would take all necessary measures.
“In the absence of aggressive central bank actions, however, the lira will continue to drop and net capital outflows will continue. Without net capital inflows, reserves will fall farther, eventually undermining Turkey’s ability to finance its current-account deficit,“ said Andy Birch, principal economist at IHS Markit.
Instead of raising rates, the CBRT cut lira reserve requirement ratios to free up liquidity to the financial system, while the banking watchdog BDDK said it would limit Turkish banks’ swap, spot and forward transactions with foreign investors to 50% of a bank’s equity.
While these actions offered some very short-term respite, it was “hard to look at these announcements as being anything more than temporary calming measures, rather than solutions to the problems at hand,” wrote Derrick.
2. Currency fix
Steve Hanke, professor of applied economics at Johns Hopkins University, suggested over the weekend that Turkey should peg the lira and adopt a currency board, a move which would force Ankara to effectively give up its discretionary monetary policy.
This would help to stabilize the currency and let Turkey rebuild its credibility in financial markets.
But that’s “not the solution as Turkey’s problems are much too complex and wide-ranging,” Win Thin, global head of EM currency strategy at Brown Brothers Harriman, said in response.
3. Capital controls
“Erdogan on the weekend continued to plea with people not to take money out of the country, but that kind of begging only underscores the lack of options,” wrote Adam Button, currency analyst at Intermarket Strategy.
The pleading led market participants to expect capital controls were under way for Turkey. The problem with this expectation, however, is that any new negative headline could trigger a major exodus of funds before the controls go into effect.
“The country’s large currency account deficit, over 5% over GDP, and the inability of the central bank to control 16% inflation has exacerbated capital flight,” Button said.
4. IMF bailout
A funding program from the International Monetary Fund would often come into play at this stage. Argentina, for example, which is also struggling with a high level of foreign debt and an ailing currency, turned to the IMF in June.
“An IMF program is one option, but the solutions are still in Turkey’s own hands,” Ash said.
But Erdogan is unlikely to agree to this, market participants said, as the president said that those calling for help from the IMF just wanted Turkey to give up its independence.
On top of that, an IMF bailout would likely have unpopular by-products such as higher taxes and lower spending, “which Erdogan is sure to reject,” Button said.
All in all, Turkey does have a few options at its fingertips, but politics and pride are making many of these measures unpalatable, complicating a quick recovery. Furthermore, market participants agreed that Turkey needed to mend its relations with the U.S. in the aftermath of the spat over the detention of Pastor Andrew Brunson.
On top of sanctions, President Donald Trump also announced tariffs on Turkish imports would be ramped up in response to the lira devaluation.
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