The Central Bank of the Republic of Turkey (CBRT) bewildered markets last Thursday with a reduction to its benchmark policy rate, even as the country’s inflation was near 80%.
Shortly after the announcement, Turkeye’s lira dropped almost 1% against the dollar, bringing the peg to over 18.1, almost a record low.
At the time of publishing, the currency is trading at 18.11 against the dollar.
While global central, to the exception of China recently, were slashing their lending interest rates by 50 or 75 basis points, Turkiye’s new policy rate was brought down to 13% from 14%, a 100 basis points drop.
Analysts had expected the country to keep rates unchanged.
On that day, the Turkish central bank said in a statement that its committee expected the “disinflation process to start” and that there are signals of a “loss of momentum in economic activity.”
In July 2018, Turkiye’s lira traded at 3.5 to the dollar, but since has lost 80% of its value and at today’s peg, high consumer prices are putting pressure on the already low purchasing power of some 84 million people living there (an estimated 6 million are expats).
To keep the Lira under control and not let it slide even further, Turkiye intervenes by either spending dollar-nominated foreign exchange reserves or preventing lira loans to companies it believes are holding too much foreign currency, but economists caution these methods are not sustainable. CBRT’s gross foreign exchange (FX) and gold reserves total just around $100 billion.
According to Cristian Maggio, head of portfolio strategy at TD Securities, as reported by Bloomberg:
“Summer markets, foreign flows from friendly countries, plus tourist high season bringing fresh hard currencies to Turkey may have helped the CBRT keep a lid over USD/TRY, avoiding a decisive break above 18. (The benchmark policy) announcement opened that lid.”
For his part, Nick Stadtmiller, director of EM at Medley Global Advisors said: “The CBRT has enough room to continue its policy mix of low rates and sustained currency intervention to slow the lira’s declines… until the middle of next year.”
Turkeye’s economic indicators
The following numbers show the depth of the crisis building in Turkeye’. The country’s foreign trade deficit reached a monthly average of $8 billion in 2022 while average gross energy imports went up from $3-4 billion monthly to $7-8 billion. An annual trade deficit of $40 billion looks to be set for 2023.
In terms of short-term external debt, some $182.4 billion of debt in hard currencies must be paid back or rolled over in 2023. Some 58.4% of this is external debt and over 70% of which are dollar-denominated.
The cost of fresh debt will be above 10% and Turkeye’s perceived risk continues to increase.
Assuming foreign currency liabilities are resolved, the CBRT’s net reserves drop to $7.5 billion, though just under 25% of reserves are owned by either central banks or local Turkish banks. And when all of these are deducted, along with existing swap agreements (including with Qatar and UAE) net reserves are in negative territory at -$54.3 billion.
Turkey is stuck between capital controls, TL depreciation, and sluggish growth. Insisting on the same policies will result in a balance of payments crisis, which is the inability to redeem foreign currency debts and pay the bills for imported goods.
In the case of runaway inflation and further currency depreciation, economic activity will slow if not stop, leading to a spike in unemployment.
In 2021, the country’s unemployment reached 13.4 %, while in April this year, it stood at 11.3%.