Turkish aversion to lira obstructs record currency rally

Turkey’s lira has rallied more than any other emerging market currency this year after the central bank renewed its commitment to fighting inflation with a series of interest rate hikes.

Hedge funds and other foreign financial institutions have piled billions of dollars back into Turkish markets to take advantage of the higher returns offered by lira assets. But their enthusiasm has not been matched by suspicious locals, obstructing further gains.

Turks, mindful of double-digit inflation and a series of policy mistakes that drove the lira to record lows last year, increased their foreign currency and gold deposits by $2.7 billion last week, according to central bank data. They sold the lira despite predictions by top global banks including HSBC and Societe Generale that the rally had further to run.

“It’s pretty incredible - Turks just don’t want to buy lira almost at any cost,” said Tim Ash, senior emerging markets strategist at BlueBay Asset Management in London. “Obviously, rates are not high enough vs inflation or Turks just don’t buy the long-term Turkey story.”

The lira has strengthened by more than 6 percent against the dollar in 2021, extending gains since a record low in early November to 20 percent. But the rally has stuttered around a key psychological level of 7 per dollar. The lira traded at between 6.95 and 7 per dollar on Friday.

Turks’ confidence in the lira has been severely dented by a currency crisis two years ago, which revived memories of extreme currency volatility and surging interest rates that characterised 1990s Turkey.

In January 2005, President Recep Tayyip Erdoğan’s government revalued the currency, lopping six zeroes off bank notes. One Turkish lira became worth 1.35 per dollar compared with 1,350,000 previously. Just prior to the global financial crisis of 2008, it was worth as much as 1.15 per dollar.

But since 2008, the currency has resumed its traditional downward path, even as a flood of global liquidity wetted investors’ appetite for emerging market assets. Lax monetary policy, a focus on economic growth, and high inflation were to blame, economists said. In mid-2014, the lira traded at 2 per dollar. By the end of 2017, just prior to the currency crisis, it was worth 3.8. The following year, it lost nearly one-third of its value. In 2020, losses totalled 20 percent.

Consumer price inflation in Turkey is now running at 15 percent, eating into consumer spending power. For many Turks, average interest rates on one-month deposits of 15.5 percent do not provide sufficient financial protection for their savings when accounting for inflation and currency risk. Three-month deposits offer rates of 17.4 percent, but three months can be a long time in Turkey.

Turkey’s central bank had kept interest rates below inflation for much of last year to help the government conjure up a borrowing boom. That prompted locals to sell tens of billions of dollars of lira, pushing up foreign currency deposits to more than 50 percent of total bank deposits. Many people bought security safes to keep their dollars and euros at home, according to local news reports.

The central bank has reacted to the exodus from the lira by more than doubling its benchmark interest rate to 17 percent since September. President Recep Tayyip Erdoğan sacked and replaced its governor in early November, bringing in former finance minister Naci Ağbal, who has pledged to deal with dollarisation and bring inflation down to 9.4 percent by the end of the year.

naci ağbal
Naci Ağbal, Turkey's third central bank governor in two years

But most economists expect annual consumer price inflation to accelerate over the next three months, further narrowing margins on returns from lira deposits. Citing the pressure on prices, some analysts have called on Ağbal to get ahead of the curve and hike interest rates again. He elected to keep them unchanged this week.

Ağbal’s hands may be tied by Erdoğan’s aversion to high interest rates. The president has reiterated his opposition to high borrowing costs several times since Ağbal’s appointment, claiming they are inflationary. He sacked a predecessor of Ağbal - Murat Çetinkaya - in July 2019 for failing to lower borrowing costs.

Still, Societe Generale and HSBC are predicting that the lira will extend gains to 6.5 per dollar by the end of the year, citing the central bank’s commitment to high interest rates and to curbing inflation, which is the highest among major emerging markets outside of crisis-hit Argentina.

Capital Economics, a London-based research and consultancy firm, predicted that the lira would rally to 6.25 per dollar by December in a report this week.

But Turks are unconvinced, partly due to a surge in food prices in recent months and lack of trust in official price data. The cost of food and non-alcoholic beverages climbed by an annual 18.1 percent in January, according to the Turkish Statistical Institute (TÜİK).

Recognising the confidence problem, TÜİK, under its new chief Muhammed Cahit Şirin, appointed on Monday, is planning to introduce a special inflation calculator for the general public named ‘My Inflation’ and to start publishing new figures for the cost of living, according to Dünya newspaper.

The independent Inflation Research Group (ENAG), formed by academics and researchers last year, calculated that Turkey’s month-on-month inflation totalled 3.15 percent in January. That figure was almost double the 1.68 percent reported by TÜİK. Food prices climbed by 5.8 percent, ENAG said.

Fifty-one percent of people in Turkey think that inflation is running at more than 30 percent annually, according to a December survey published by research company Metropoll. Just 11.9 percent of respondents said inflation was in line with official data.

Turks are also mindful of political risks. Erdoğan’s government responded to nationwide student protests last month by sending in riot police and detaining hundreds of demonstrators, reviving memories of the destabilising Gezi Park protests of 2013.

Erdoğan is also embroiled in a political spat with the United States over his government’s purchase of Russian S-400 air defence missiles in 2019. Congress has threatened harsh economic sanctions in return. A limited list of sanctions approved by President Donald Trump in August 2018 to punish Turkey for its detention of an American pastor on terrorism charges helped provoke the currency crisis.  

The opinions expressed in this column are those of the author and do not necessarily reflect those of Ahval.