What Led To The Collapse Of The Lira And What Should Investors Do Next
Turkey’s currency has been in free fall in recent months. Just about a year ago, you could purchase the U.S. dollar for approximately 3.5 lire. Today, you will have to pay almost double that amount for the same privilege.
The precipitous drop in the value of the lira is an amalgam of political and economic factors. Turkey’s president, Recep Tayyip Erdogan, has been unable to stop the slide, and it is entirely possible that the U.S. dollar will continue to strengthen its position in the days and weeks ahead.
The roots of the lira’s fall could be traced back to the 2016 coup attempt in Turkey. Although the uprising was a failure, the violence caused 250 deaths in the country and left 1,400 wounded. The heavy-handed clean-up by the Erdogan regime saw over 120,000 people from the military, academic institutions, media, and civil service losing their jobs or being detained.
According to the president’s supporters, the mastermind of the coup is Fethullah Gulen, a former ally of the ruling party. He lives in the U.S. and Turkey has been trying, unsuccessfully, to get him extradited.
The period immediately following the coup attempt witnessed another critical development. The Turkish government arrested an American pastor, Andrew Brunson, who runs a small church in Izmir in western Turkey. He has been in the country for the last two decades. Andrew Brunson’s crime? The authorities say that he was part of coup leader Fethullah Gulen’s network.
The U.S. government counters that the Turkish authorities do not have any proof against Mr Brunson and that he should be released immediately.
When there are problems of this nature, the usual practice followed by the Americans is to impose sanctions against the offending nation. But in this case, President Trump has chosen to hike tariffs to retaliate against Turkey’s intransigence. On 10 August, Trump tweeted:
I have just authorized a doubling of Tariffs on Steel and Aluminium with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!
Turkish lira in free fall
Source – CNN
Turkey’s economy is struggling
The American action is only one of the reasons for Turkey’s woes. The country’s economy is struggling, and ordinary citizens are feeling the impact.
GDP growth has been severely affected. According to the International Monetary Fund, Turkey’s economy will witness a slowdown this year. In 2017, the country registered a growth of 7%. This figure is expected to fall to 4.4% in the current year.
Inflation is another major worry. In a recent CNBC report, Steve Hanke, who has served on President Ronald Reagan’s Council of Economic Advisers, points out that Turkey’s annual inflation rate is currently 101%.
Source – CNBC
High inflation rates have led to a sharp depreciation in a country’s currency. The only way to arrest inflation in the country, according to Mr Hanke, is to set up a currency board. That’s a system that requires the management of the nation’s exchange rate and the money supply to be taken away from the central bank. The new currency board would peg the exchange rate of the lira with a foreign currency and would maintain an equal amount of the foreign currency in its reserves. It’s highly unlikely that Turkey will peg the lira to the U.S. dollar, so this solution seems to be a non-starter.
What, me worry?
The task of revitalising the economy and stabilising the lira has fallen on Turkey’s new finance minister, Berat Albayrak. In a recent conference call with overseas investors and bankers, he promised that conditions would improve soon.
Berat Albayrak, who also happens to be the president’s son-in-law, said that Turkey had no intention of approaching the International Monetary Fund for help in resolving the crisis. Neither would the authorities clamp down on foreign currency outflows from the country.
Then, how does he plan to tackle the economic turmoil within Turkey, and especially the rapid decline in the lira’s value?
One step that the government has taken is to retaliate against the tariffs imposed by the U.S. It has doubled its tariffs on American passenger cars, alcohol, and tobacco. President Erdogan has called upon the country’s citizens to sell their dollars and euros so that the lira’s valuation improves.
The Turkish government is also relying on international investors to support the nation’s economy. Qatar has pledged to invest U.S.$15 billion.
Turkey is simultaneously trying to negotiate a political solution. It has offered to exchange the American pastor it has detained with Fethullah Gulen. Referring to America’s demand to free Andrew Brunson, President Erdogan said, “‘Give us the pastor back’, they say. You have one pastor as well. Give him (Gulen) to us. Then we will try him (Brunson) and give him to you.”
Why the lira’s collapse matters
Emerging market stocks have taken a beating this year. Is the lira’s fall responsible for declining share prices in several countries? It is not the sole reason, but Turkey’s economic and currency problems have played a part in the gloom surrounding stock valuations.
Source – Reuters
One major problem that could rear its head soon is that of the corporate debt in foreign currencies of Turkish firms. This has more than doubled in the last nine years. It stood at U.S.$328 billion at the end of 2017. Many global banks have significant exposures to Turkish debt. Spain’s banks top the list with a figure of U.S.$81 billion. French banks have lent U.S.$35 billion to borrowers in Turkey while Italy’s figure is U.S.$18.5 billion.
If Turkey defaults on this debt, the repercussions could be severe.
Should investors in emerging market equities be worried?
The MSCI Emerging Markets Index is down about 5% in the first seven months of this year. However, that should not be of much concern if you have a long-term outlook. Emerging markets have traditionally provided “lumpy” returns:
Source – CNBC
But if you measure your investment horizon in weeks and months instead of years, you could have a difficult job ahead. It’s anybody’s guess as to when the slide in emerging market currencies and stock markets will stop and reverse itself. Kevin Daly, a money manager at Aberdeen Standard Investments in London, says, “Playing a market like this is difficult. There aren’t any obvious safe zones.”