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Turkey’s currency crisis deepens after Erdogan’s latest rate cut

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Turkish Lira

Mehmet Kalkan

Turkey’s currency crisis intensified on Friday. It plunged 8.8% to a record low. The country is gripped by worries about an inflationary spiral that President Tayyip Erdogan has initiated. His unconventional plan of cutting interest rates against soaring prices was causing it to plummet.

The lira hit 17.0705 to the dollar, triggering direct central bank intervention in the market to prop up Turkey’s battered currency — its fifth effort this month to address what it called “unhealthy” prices.

Dollar-buying by the bank reduced the losses of 16.5 liras to 1116 GMT. At this level it has still lost 55% of its value this year — including 37% in the last 30 days alone — deeply unsettling the major emerging market economy.

Erdogan’s announcement to increase monetary easing by 500 basis points since September and a big reduction on Thursday has sent inflation above 21%. Economists predict that it will surpass 30% in 2013 due to a surge in import prices and an urgent increase to the minimum wage.

Erdogan appears to have become more entrenched in anti-interest rate stances. Turkey may be past the point of no returns,” Patrick Curran from Tellimer said. The lira is described as being completely detached from its fundamentals.

His comments about the possibility to reinvest in Turkish assets were, “We still aren’t ready to capture the falling knife.” Erdogan at the helm, there’s nothing that can stop the lira continuing to decline.”

As Turks watched their earnings and savings disappear, the knock-on effects were swift and severe.

Erdogan has announced that the minimum wage will be increased by 50% to 4,250 lire ($275) per calendar month. This is however expected to raise overall consumer price inflation between 3.5-10 percentage points.

This raise affects six million workers, however, due to sharp lira appreciation, the new minimum wages is still lower that the $380 equivalent a year prior.

“We believe that the current mix of policies is essentially unsustainable,” Maxim Rybnikov, director sovereign ratings for the EMEA region at S&P Global Ratings, said in a webcast.   

Reassessment of the policy framework

Turkey’s 2018 currency crisis, which caused a severe but temporary recession in 2018, has been outpaced by the market collapse.

Tradeweb reported that Turkey’s dollar denominated sovereign bonds came under increasing pressure. Spreads on U.S. Treasuries have widened to 579 basispoints, with 28 bps more since last Friday’s close.

Data from IHS Markit revealed that five-year credit default Swaps increased 3bps to close 529 bps Thursday. This is their highest point since Dec. 6.

Turkey’s real rates fell further into negative territory after the central bank cut its 100-basis point rate on Thursday.

It indicated that it will pause the easing cycles to observe its effect over the next three-months. “All aspects of the policy framework” would be reviewed to ensure a stable price environment.

Rybnikov suggested that other channels of interest could be considered. In past times, central banks have used interest rate corridors to determine rates.

Rybnikov said that capital controls may be more likely if the rate-cutting cycles continues. They would not be our baseline…we think they could be used last resort as a policy measure.”

Even though Erdogan refused to change course even within his own government, traders expect it to happen quickly. From 12% in the beginning of the year, the benchmark 10-year yield is now 22.5%.

JPMorgan, a Wall Street bank predicted that interest rates would rise by 12 percent next year. This is more than any other Turkish peers.

Erdogan is urging the central bank to cut rates to stimulate economic growth and lend more to exporters under his economic plan.

Opposition lawmakers and economists have criticized this policy widely as being reckless.

Four times the central bank intervened on the currency market within the last week, buying dollars to slow down the lira slide.

This year, the lira plunged 51% to the euro and 54% to sterling.

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