Just when Turkey had hopes of improvement the Lira has plunged again

The weekend just gone was a long one in the UK as for those unaware the UK has a proliferation of bank holidays at this time of year and then none at all until the end of summer. During that time we saw President Trump try to dominate the news with has new trade tariffs only for him to discover that a Royal Baby trumps everything. The latter news would be welcome in Turkey although sadly for this particular perspective the Ottomans are long gone. Thus they cannot help with this development. from yesterday.

The Turkish lira is tanking after the countries highest electoral body overturned the municipal election results in Istanbul. Far and away the worst performing major currency today. ( @TheStalwart )

So far today the situation continues to deteriorate according to @IGSquawk.

Turkish LIra once again getting hammered this morning: -1.61% against other currencies

6.17027 +1.46%

6.92511 +1.61%

8.10287 +1.66%

17.918 -1.55%

Somebody has tweeted that  at one foreign exchange bureau at Gatwick Airport if you wish to switch from Turkish Lira to Sterling you have to pay 10.09 which is a version of usury really.

How did we get here?

The situation was exacerbated by the election or perhaps I should say second election news but there were issues on the horizon as it was. Let me illustrate from Reuters.

 Turkey is ready to provide its full support to international investors, President Tayyip Erdogan said on Saturday, adding that while attacks on the economy via its currency continued, the government was in control of the situation………“While efforts to collapse our economy through the foreign exchange rate continue, we have control now,” Erdogan told Turkish businesspeople in Istanbul.

This is a familiar feature of a foreign exchange crisis as it is a cheap hit for a politician to blame foreigners and with the emphasis on them being for some reason speculating against the country in question. Maybe one or two do but in general currencies are sold because of other events and there have been some. For example President Erdogan might like to look at his own words according to Reuters from last Thursday.

“Together, we will win this battle against those trying to trap Turkey in the exchange rate, interest rate and inflation plot,” he said in a speech to business people in Ankara. “We are certainly determined to lower exchange rates, interest rates and inflation to targeted levels,” he added.

For those unaware Erdogan has also advanced the theory that lowering interest-rates will reduce inflation. So he had been digging under the foundations of the Turkish Lira which added to the debate over what was going on with the foreign exchange reserves.

The Financial Times reports that Turkey’s currency reserves may not equal the $28.1 billion touted by the central bank. Instead, they could be inflated by short-term borrowing via swaps. Strip those out and reserves total only $16 billion. ( forexlive in Mid-April).

It is not that unusual for a central bank to borrow to boost its reserves but the crucial phrase here is “short-term” which raises the issue of what happens if the borrowing matures before any crisis ends? So as you can see the currency was on yellow alert and a combination of the tariff and re-election news switched the yellow to red.

The defenders

There are two main defences here which are interest-rates and the reserves we have just looked at.

The Central Bank of Turkey increased its benchmark interest rate on Thursday to 24 percent, a hike of 625 basis points from the previous rate of 17.75 percent. ( CNBC last September)

They are still there and Turkey has been using its reserves also to support the currency. Also there have been examples of state banks buying too. The operation seemed to be trying to hold the Lira below 6 versus the US Dollar which is another reason for the sharp rise now as the defenders got beaten, a bit like in football where a team resists the first goal for ages but after it they let in several more.

The economy

Back on the 13th of July last year I pointed out this.

A sharp brake has been applied to the economy via the higher cost of imports and via higher interest-rates.

Actually interest-rates had only risen to 17.75% back then so more was to come. Also I highlighted problems in the energy industry in particular because it had borrowed in US Dollars and the current issue with the reserves reminds me of this.

This is also familiar as countries which are in danger of trouble make it worse by borrowing in a foreign currency because it is cheaper in interest-rate terms. After all what could go wrong?

As to the economy let us switch to the central bank or TCMB inflation report from the end of last month.

In the final quarter of 2018, GDP decreased by 3.0% on an annual basis and by 2.4% on a quarterly basis.

So the sharp brake is being applied and also there is this.

While the contraction in economic activity in the final quarter of 2018 was driven by domestic demand conditions, net exports continued to underpin growth and the rebalancing trend in the Turkish economy became more apparent.

What Talking Heads would call the “Slippery People” bit is the use of “net exports” which can easily be confused and read as exports. You see the contraction in domestic demand boosts GDP via net exports and flatters the numbers which is really very different to an export boom. It is a version of what is called the J-Curve and indeed the reverse J-Curve in economic theory.

The Ankara Times has kindly highlighted this.

Turkey’s foreign trade deficit in the first quarter of this year fell 67.4% year-on-year, the country’s statistical authority announced on Tuesday.

The figure totaled some $6.8 billion from January to March, improving from a $20.7 billion deficit in same period last year, according to TurkStat.

Turkish exports rose to $42.2 billion — up 2.7% on a yearly basis — while imports slipped to $49 billion, down 20.8%.

So the GDP boost on last year is US $13.9 billion which is welcome. But the vast majority of the gain is lower imports which means that the GDP numbers are flattered when people are worse off which is another flaw to add to our list of issues with it. Putting it another way there are similarities with what happened to Greece where reality was flattered before a later “surprise”, which if you look more deeply is no surprise at all.

As to inflation the objective of single figures remains far away.

In March, consumer prices were up by 1.03% and annual inflation rose by 0.04 points to 19.71%. In this period, annual inflation increased in food and energy groups while it decreased in the core goods group. The rise in annual food inflation was driven by the significant hike in prices of fresh fruits and vegetables.

The ordinary worker and consumer will not welcome the rise in food and energy prices in particular. If you are fortunate to be able to spend in a foreign currency over there then some good are cheap as for example I have been told a litre of petrol at the pump is 90 pence. That will help with tourism income.

Comment

Just over a year ago on the third of May I published my view on how to deal with a foreign exchange crisis.

So a central bank can fight a currency decline but the truth is that it can only do so on a temporary basis…….However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one. As to building up foreign exchange reserves by borrowing.

Whilst my emphasis was on Argentina we see that Turkey has raised interest-rates to 24% and continues to apply them thus crunching the domestic economy with not only no sign of a let up but rather perhaps the reverse. I was also way ahead on the issue of borrowing to support your currency reserves.

Moving to the specific I did get to Turkey.

Good market spot: Turks are buying gold to hedge against booming inflation and a falling currency ( Lionel Barber)……Anecdotally central London agents tell me they are seeing an increase in Turkish buyers this year ( Henry Pryor)

How have they done? As the US Dollar is up 44% and the UK Pound 40% pretty well although as individual markets both gold and London property have had better years. Actually when you look at the performance of the Turkish Lira which was ~1.3 to the US Dollar at the beginning it is hard to lose by investing abroad and that of course is part of the problem.

But returning to a pure economics mandate just when some factors are beginning to help Turkey has returned to the same set of problems.

Podcast

Turkey sees currency driven inflation beginning to fade as the Lira rallies

A feature of the modern era is the way that we are presented crises but they then fall off the radar screen. An example of this has been Turkey which hit the media heights but has now faded away. Let us update ourselves via the view of Commerzbank on last months central bank meeting.

The Turkish central bank (CBT) left its benchmark interest rate unchanged at today’s meeting. In our view, this was a major policy mistake. CBT commented that it maintains a tight policy stance. But, when the benchmark rate is 24% and inflation is also 24%, how is this stance “tight”? The decision shows that CBT has not morphed into an active inflation-targeting central bank as some government officials have claimed. Rather CBT is simply taking the path of least resistance – since the market is forgiving at the moment, why ruffle political feathers by continuing to hike rates? Given this CB attitude, prepare for more lira volatility down the line.”  ( via FXStreet )

There is a large amount to cover here and let us start with the idea that a major mistake was made. Also that this from the CBRT is wrong.

The tight stance in monetary policy will be maintained decisively until the inflation outlook displays a significant improvement…….Accordingly, the Committee has decided to maintain the tight monetary policy stance and keep the policy rate (one week repo auction rate) constant at 24 percent.

There are many ways of measuring such a concept but an interest-rate of 24% on its own in these times makes you think, especially if we recall that it had been raised by 6.25% at the previous meeting. How many countries even have interest-rates of 6.25% right now? The real issue here to my mind is that Commerzbank  lost perspective with this by looking at inflation at the moment rather than looking ahead. If we take the view of the CBRT from back then the outlook was this.

In this respect, inflation is projected to be 23.5 percent at end-2018, and then fall to 15.2 percent at end-2019 and 9.3 percent at end-2020 before stabilizing around 5 percent in the medium term. Forecasts are based on a monetary policy framework that envisages that the tight monetary policy stance will be maintained for an extended period.

On this basis if we look ahead to when we might expect the interest-rate rise to be fully effective we should start with the end-2019 figure of 15.2%. Against that outlook then a real interest-rate of 9% is for these times eye-wateringly tight. Of course caution is required as central banks are hardly the best forecasters, But I am reminded of the template I set out on the third of May for such a situation.

However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one.

My warning was given when interest-rates in Argentina were 30.25%, by the end of that day they were 3% higher and now the LELIQ rate is 68.1%. Sadly they are living out my warning.

Inflation now

Let us bring this up to date from the Hurriyet Daily News.

Turkish annual inflation surged to 25 percent in October, official data showed on Nov. 5, hitting its highest in 15 years……..Month-on-month, consumer prices jumped 2.67 percent, the Turkish Statistical Institute (TÜİK) data showed, higher than the 2 percent forecast in a Reuters poll. Core inflation surged 24.34 annually. October  inflation was driven by a 12.74 percent month-on-month surge in clothing and shoe prices and a 4.15 percent rise in housing prices, the data showed.

On a yearly basis, the biggest price hike was in furnishing and household equipment in October with 37.92 percent.

Initially Commerzbank may think it was right but this is only a small nudge higher in annual terms as the monthly increase more than halves. We also get a reminder that this is inflation which is essentially exchange-rate driven by the way that the core inflation rate is so similar to the headline. This is joined by which sectors are influenced by imports showing it is a bad time to overhaul your wardrobe or redecorate your home. Speaking of homes there will be central bankers reading this thinking that the rise in house prices is a triumph. The wealth effects! The wealth effects! Back in your box please.

The Turkish Lira

There have been changes here as we look to see what influence it will have on inflation trends. Here is @UmarFarooq_

Turkish is regaining some of its loses, looks set to return to pre-sanction days of August. Went from 6.3 to 5.3 versus dollar in one month. Still a ways to go compared to one year ago, when it was 3.8

Some of the move has been in relation to political changes but from our point of view that only matters if they intervene again. The fact is that a lot of inflationary pressure has faded in the move from the peak of 7.21 against the US Dollar at the height of the crisis to 5.34 as I type this.

So whilst there is still inflationary pressure in the system it has faded quite a lot and if you believe World Economics things are still out of line.

The Turkish Lira has an FX rate of 5.7 but a PPP value of 2.72 against the USD. ( PPP is Purchasing Power Parity)

Of course with inflation so high PPP may need a bit of an update.

Comment

The exchange-rate is the (F)X-Factor here but the inflation trend is now turning although due to base effects the headline may not respond for a couple of months or so. In some ways like so many things these days events have sped up and it has been like a crisis on speed. Here is the latest official trade data via Google Translate.

Our foreign trade deficit decreased by 92.8% to 529 million dollars in October compared to the same period of the previous year……..October, our exports increased by 13.1% compared to the same month of the previous year and reached 15 billion 732 million  dollars. Our exports increased to the highest level of all time and 
broke the record of the Republican history. 
In October, our imports decreased by 23.5 percent to 16 billion 261 million dollars.

There is an intriguing hint that the Ottoman export performance may have been quite something but we learn several things. Turkey seems to have a very price competitive economy as we see both exports and imports responding in size and in short order. We also have a large slow down and indeed recessionary hint from the size of the fall in imports. Next we admire their ability to have the October figures available on the 1st of November. Also if we look at the year so far you might be surprised at one of the names below.

In January-October period, exports to Germany increased 8.7% to $ 13.5 billion, while exports to the UK increased 17.5% to $ 9.3 billion.

Also Turkey seems to have avoided the automotive slow down which today has spread to Ford suppliers in Valencia.

Thus looking ahead the inflationary episode is now fading as ironically another consequence of the lower exchange-rate which is trade looks to be moving into surplus. For once the real economy is moving as quickly as the financial one. However one aspect that we do not know yet is the size of the slow down or recession partly because a sign of it – lower imports – flatters GDP via trade and often more quickly than the other numbers we receive show the actual cause of it. If you want a Commerzbank style Turkish economy imagine all of the above with another interest-rate increase……