Today we have an example of an exception proving the rule. Indeed it is something so rare in these days of negative interest-rates that I hope you are all sitting comfortably.
ISTANBUL (Reuters) – Turkey’s central bank raised the interest rate in its lira swap operation to 11.75% from 10.25% on Friday, continuing additional tightening steps in the face of a weakening lira after unexpectedly hiking its benchmark interest rate last month.
Following the rate hike in its swap transactions, the lira rebounded to near 7.90 against the U.S. dollar from a record low of 7.9550 earlier in the day. It had eased back to 7.9375 as of 1010 GMT.
Today is full of hints or more interest-rate cuts in China and Europe but Turkey has found itself raising them again, albeit in an official way. But as you can see the initial reaction in terms of the Turkish Lira was along the lines of “meh”.Actually the Turkish Lira did rally later to 7.84, but that was from another perspective only back to where it was on Wednesday and this morning it is back to 7.89.
Turkish Lira Troubles
It has been a hard year as Bloomberg points out.
Turkey’s lira depreciated to a record against U.S. dollar, decoupling from other emerging-currencies amid mounting geopolitical risks in the region.
The lira fell as much as 0.9% to 7.8692 per dollar, extending losses this year to more than 24%, the second-biggest slide in emerging markets after Brazil’s real.
As you can see that level got replaced and in spite of the unofficial interest-rate rise we are below it now. Regular readers may well recall that the Lira was slip-sliding away and hitting new lows back in the summer of 2018 and the move through 6 versus the US Dollar was regarded as significant whereas now we are on the verge of 8 being the big figure.
Because of the economic links the exchange-rate with the Euro is significant. Indeed some Euro area banks must be mulling their lending to Turkish borrowers as well as Euro area exporters struggling with an exchange-rate of 9.32. That is some 43% lower than a year ago.
Whilst we are discussing big figure changes we see that the UK Pound £ now buys more than ten Turkish Lira.
This is the obvious initial consequence of an exchange-rate depreciation.
In August, consumer prices rose by 0.86% and annual inflation remained flat at 11.77%. While annual inflation rose in core goods, energy and food groups, it remained unchanged in the services group. Meanwhile, annual inflation in the alcoholic beverages and tobacco group declined significantly due to the high base from tobacco products
That is from the latest Minutes of the Turkish central bank or TCMB and in fact the impact is even larger in essential goods.
Annual inflation in food and non-alcoholic beverages increased by 0.78 points to 13.51% in August. The rise in annual unprocessed food inflation by 1.51 points to 15.36% was the main driver of this increase.
As important is what happens next and here is the TCMB view.
In September, inflation expectations continued to increase. The year-end inflation expectation rose by 64 basis points to 11.46%, and the 12-month-ahead inflation expectation increased by 45 basis points to 10.15%.
With the ongoing fall in the Lira that looks too low to me. On the other hand I think that Ptofessor Steve Hanke is too high.
I can see how goods inflation might have such influences but other prices will not respond so mechanically.
You might think that an ever more competitive economy in terms of the exchange-rate would lead to a balance of payments triumph. However this morning’s figures tell a different story.
The current account posted USD 4,631 million deficit compared to USD 3,314 million surplus observed in the same month of 2019, bringing the 12-month rolling deficit to USD 23,203 million. ( August data).
There are two highlights here. It is significant that the release is in US Dollars and not Turkish Lira. But we also note that Turkey has gone from surplus to deficit about which we get more detail here.
This development is mainly driven by the net outflow of USD 5,347 million in the good deficit increasing by USD 3,948 million, as well as the net inflow of USD 1,179 million in services item decreasing by USD 4,602 million compared to the same month of the previous year.
One factor at play in the services sector weakness is tourism. If we look at the year so far we see this is confirmed by a surplus of US $4.15 billion as opposed to one of US $19.17 billion in the same period in 2019. Another way of looking at this is that 3,225,033 visitors are recorded as opposed to 13,349,256 last year.
The problem here is also what is called the reverse J Curve effect where imports have become more expensive but it takes time for volumes to shift as well as it taking time for more orders to come in for the relatively cheaper exports. At the moment that is exacerbated by the pandemic as for example if we stay with tourism international travel has fallen and with further restrictions possible it may not matter how cheap you are.
Staying with theoretical economics we should be seeing the J Curve effect from the 2018 devaluation but right now as we have noted with tourism practicalities are trumping theory.
We get some context here if we note this from Bloomberg.
Meanwhile, Turkey paid a premium as it sold $2.5 billion of debt to international investors on Tuesday, it’s first foray into global markets since February. The bonds priced at 6.4%, compared with 4.25% for similar-maturity notes issued in February.
We note the fact that we have another trend reversal here as most countries have seen lower debt costs whereas Turkey is paying more. The theme of borrowing in US Dollars is a Turkish theme though and in terms of the money raised each one has so far been a success as in it would have been more expensive later. The catch is when we get to interest payments and repayments which have got ever more expensive in Turkish Lira. So if your income is in US Dollars or other overseas currencies you are okay but if it is in Lira you are in trouble.
According to the TCMB here is what is coming up from its July data.
Short-term external debt stock on a remaining maturity basis, calculated based on the external debt maturing within 1 year or less regarding of the original maturity, recorded USD 176.5 billion, of which USD 15.9 billion belongs to the resident banks and private sectors to the banks’ branches and affiliates abroad. From the borrowers side, public sector accounted for 23.9 percent, Central Bank accounted for 11.4 percent and private sector accounted 64.7 percent in total stock.
August saw an outflow from the TCMB as well.
Official reserves recorded net outflow of USD 7,602 million.
They started the year at US $81.2 billion and are now US $41.4 billion.
So far we have noted a financial sector which is in distress with rising interest-rates a falling currency and overseas borrowing in a toxic mix. Let us now switch to the real economy where these will impact via general inflation highlighted by foreign goods and services being much more expensive. So living-standards will be lower. The normal mechanisms where a currency depreciation can help an economy are in many cases being blocked by the Covid-19 pandemic. Only on Friday we observed that the UK has been importing less which is pretty much a 2020 generic. This is added to be the fact that a Turkish economic strength ( tourism) has had an especially rough 2020.
There are other issues here as the continual foreign currency depreciation has led to a surge in demand for safe assets.
A significant part of the deterioration in the current account balance is due to gold imports. This year, gold imports will exceed $ 20 billion. ( Hakan Kara)
Gold of course exacerbates the US Dollar issue as it becomes increasingly important in Turkey. Actually the central bank has joined the game as its Gold reserves have risen by some US $17 billion so far this year and whilst some of that is a higher price it must also have bought some more.
Will more interest-rate increases help? I am not so sure as they are usually much smaller than the expected fall in the currency and they will crunch the economy even further. It would help of course if Turkey was not either actually in a war or acting belligerently on pretty much every border it has. Putting it another way government’s in economic trouble often look for foreign scapegoats.