The Turkish lira fell to a new record low late last week. This followed a meeting on Thursday between a Turkish delegation and US officials in Washington, which yielded no apparent solution to a worsening diplomatic rift over the detention in Turkey of a US pastor.
Following announcements over the weekend of government plans to tighten fiscal policy, on Monday 13 August, the Turkish central bank announced liquidity measures and changes in the reserve requirements for the banking system. But will this be enough to stop the rot and stem the lira’s precipitous fall? Probably not. The general consensus seems to be that this is too little, too late and that a serious interest rate hike will now be necessary to support the ailing currency, which has fallen over 30% year to date. The absence of any mention of a rate hike also raises doubts as to the independence of Turkey’s central bank and its ability to take action.
Aside from the worsening political backdrop, the key problem for Turkey is the government’s sole focus on GDP growth at the expense of maintaining a sustainable path for the economy. President Erdogan has kept up the pressure on the Turkish central bank to maintain a loose monetary stance, while his government pursues economic policies aimed at supporting GDP growth. The flip side to this strategy is rapidly rising inflation, now close to 16% and a current account deficit which is above 6% of GDP and widening. These two factors and foreign currency debt hovering at around 69.5% of GDP together form a powerful recipe for a weakening currency.
While a sudden and deep currency depreciation is an undesirable development for any country, for Turkey this is exacerbated by the fact that this year its gross external financing requirements are a hefty USD 230 billion. This means the lira’s demise is putting a real strain on the private sector’s ability to service its debt. If the lira remains at these depressed levels, companies will have to divert an increasing portion of their cashflows to repay debt, which will impact earnings, capex, and ultimately the GDP growth that president Erdogan is so keen to stimulate. It also increases the likelihood of defaults at corporate level. Such a scenario could trigger a further correction in the currency, even beyond current levels, as well as in the equity market, unless measures are taken at a political, fiscal and monetary level.
Although the currency is now starting to look relatively cheap, we still believe that an effective policy response will be required to stem its slide. A tightening of monetary and fiscal policies, a commitment to an independent central bank that can raise interest rates, and a political understanding with the United States could turn around the situation in Turkey. However, so far, President Erdogan’s hard stance towards the US and the reaffirmation of his belief that high interest rates actually trigger high inflation do not make this seem likely to happen any time soon. Yet, we hope that at some point economic common sense will prevail. If it doesn’t, Turkey will be restricted to options such as asking the IMF for help or, in more extreme circumstances, introducing capital controls and even defaulting on its debt.
However, this scenario seems unlikely at this point and it is certainly highly undesirable. First, the IMF would impose strict fiscal and monetary conditions, which Turkey would most likely be unwilling to accept. Second, both capital controls and debt default would be extremely negative for the Turkish economy as the country needs access to the international capital markets for its economy to function. Furthermore, there is little likelihood of a sovereign debt default, given the relatively limited level of public debt to GDP. Currently, external sovereign debt is only around 28% of GDP.
A more sustainable solution would be to tighten monetary policy by hiking rates and at the same time implement more conservative fiscal policies aimed at lowering the current account deficit, rein back credit expansion and get inflation under control. Such policies, however, would trigger a slowdown of GDP growth, something which up until now President Erdogan has not been willing to let happen.
The fundamental equities strategies do not hold any positions in Turkey and we believe this is the appropriate stance, given the economic and political uncertainty. First we would like to see a greater focus on economic restructuring, less debt creation and lower economic imbalances, before taking any new positions.
Our quantitative equities strategies do not take macroeconomic or currency-related factors into account in their model-based bottom-up stock selection process. As a result of this approach, some Turkish stocks are attractive resulting in a relatively limited overweight exposure to the Turkish stock market. We will monitor the situation in Turkey and liaise with the fundamental emerging markets equity team as developments unfold.
Some of the Robeco credit funds have an off-benchmark exposure to Turkey. The positions are small at around 1.5% in terms of market weight and are in good quality names. We maintain the overall risk profile of the fund at around index level as our positioning is relatively conservative. The funds do have some indirect exposure to Turkey via European banks. Although these may suffer somewhat, we are comfortable with our overall positioning in Turkey and will be looking for any opportunities that may arise as a result of the current situation.
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