We touched on President Erdogan’s unconventional monetary policy a couple of weeks ago, and it’s DEFINITELY time to revisit!
Take a look at this weekly USDTRY chart
You can see that something has happened, but it’s hard to put that chart into proper context. As recently as September, one US dollar was worth nine Turkish Lira. In the space of six weeks that essentially doubled. You would need as much as 18 Turkish Lira to buy one dollar.
Until yesterday that was! President Erdogan announced extraordinary measures to halt the Lira’s slide. The government will now cover any losses incurred by holders of lira deposits if the lira’s decline against ‘hard’ currencies exceeds the interest rates they could receive in Turkish banks.
“From now on, none of our citizens will need to switch their deposits from the Turkish lira to foreign currencies because of their concerns that the exchange rate fluctuations might wipe out gains from interest payments”
The market was definitely caught off guard by the announcement:
An enormous liquidity gap that saw TRY move from over 18 to just under 12 in two and a half hours. A gain of ~35% for the Turkish lira!
The story is far from over however.
It’s not just gains from interest rate payments the people are worried about. The instability of the lira risks permanently undermining confidence in the currency, and markets aren’t convinced this is anything more than a temporary solution.
Erdogan insists that he will persist with the ‘new economic model’ that seeks to capitalise on low rates to reduce inflation:
“Of course we know that price rises are causing problems in the daily lives of our people. Of course we are aware of the volatility in the exchange rate, the instability in prices and the uncertainty this creates,”
“But we will resist these just as we resisted tutelage, terrorist organisations, putschists and global power barons. I am telling you, there is no going back. Don’t expect anything else from me,”
Erdogan has even invoked religion and referenced the Islamic proscriptions of usury:
“As a Muslim, I’ll continue to do what is required by nas,”
(Many Muslims believe that Sharia prohibits the earning of interest on loans, known as riba)
So the policy of pushing rates lower will continue, and the instability will deter foreign investors. Which begs the question…
Who funds the difference?
And the answer would seem to be… everyone! Turkey’s fiscal position is relatively strong. Now that’s on the hook to ‘pay’ for the depreciation of the lira further down the line, so the costs of this monetary adventure will likely fall on the country as a whole.
Ultimately, inflation is still way above the rate of interest (over 20% inflation vs 14% interest rate), and this gap looks set to widen. Due to the currency depreciation, inflation should stay high, while Erdogan eventually wants to bring rates down to zero.
He’s also (understandably) coming under pressure with the opposition calling for early elections.
Many analysts are saying this is merely a brief respite and the fireworks will resume in fairly short order. One thing’s for sure, trading the Turkish Lira is not for the faint-hearted!
Not investment advice. Past performance does not guarantee or predict future performance.