Marc Jones and Tommy Wilkes

LONDON, (Reuters) – The central bank ignored warnings about a currency collapse and high inflation and slashed its interest rates by 100bps on Thursday.

Tayyip Turkey, President of the Republic, believes lower interest rates are necessary to control inflation. His central bank chief hinted that another rate cut could be in his future.

Turkey is now at risk of even more inflation, possibly 30%. The currency will also be in meltdown unless rates and the course change.

These charts explain what is behind the woes of the lira.

1. SLUUMP, JUMP, AND SLUMP AGAIN

Turkey is the biggest economy in the Middle East, and 20th largest in the world. It has experienced two severe contractions over the past two years, and since mid-2018, its currency has lost two-thirds.

After a confidence-restoring change in the central bank governor and finance minister, there was some relief for the lira. It rose more than 20% between November 2020 & February 2021.

Erdogan resigned as governor of Turkey in March, and investors claim that any credibility is gone. The new chief will deliver a string rate cut.

Graphic: Turkey’s lira https://fingfx.thomsonreuters.com/gfx/mkt/zjpqkwmdrpx/lira%20decade.PNG

2. AMMUNITION RUNNING AT LOW RATES

While the IMF has helped to increase central banks’ reserve, they still have negative reserves. Analysts say this is due to a variety of funding agreements with local banks.

As of November 12, Turkey had $28.61 trillion in net FX reserves. It’s a substantial increase over the April levels, which were sub-$10 million.

However, $43.44Billion of outstanding Swap transactions are held by the bank, which means that the reserve is technically 15 billion.

Graphic: Turkey’s currency reserves https://fingfx.thomsonreuters.com/gfx/mkt/zgvomklljvd/Pasted%20image%201637254041981.png

3. CRISIS IN OUR BALANCE

Turkey’s current account deficit is also smaller than it was in the past. According to the chief of the central bank, addressing this deficit will be key for achieving price stability.

Capital Economics warns that a looser monetary policy in an environment where the economy is already above its pre-COVID trend could cause imbalances to grow and lead to another balance of payment crisis.

Graphic: Turkey’s balance of payments https://fingfx.thomsonreuters.com/gfx/mkt/dwpkreyywvm/Pasted%20image%201637257931363.png

4. ISN’T A NEW CUT IN COMING?

The interest rate cut on Thursday leaves the rates unchanged at 15%, and approximately 500 basis points lower than October’s reading of near 20%.

The central bank raised interest rates by 24% in 2018, a period when the lira was falling at a rapid pace. This was seven percentage points higher than inflation, which occurred before stabilisation.

JPMorgan (NYSE): “Noting the risk for further cuts,” JPMorgan said following Thursday’s policy conference.

Graphic: Turkey rates and inflation https://fingfx.thomsonreuters.com/gfx/mkt/mypmnkyymvr/turkey%20rates%202.PNG

5. NOT SO APPEALING

Fitch, a ratings agency that assesses Turkey’s financial situation, says the government of Turkey and its businesses need to refinance $174.5 million each next year.

But Turkey’s real yields, adjusted for inflation, are below their peers. They make them less appealing to overseas investors.

Paul Gamble of Fitch, one of Fitch’s leading sovereign analysts said, “While we’ve had the issue of lack of central bank credibility for a while, what are we looking at now is the fallout elsewhere — how it affects the ability of banks and corporates that meet their financing needs.”

Graphic: EM real yields https://fingfx.thomsonreuters.com/gfx/mkt/znvnekmmkpl/turkey%20real.PNG

6. HOUSEHOLDS HURT

As Turkey recovers from the pandemic, according to The International Monetary Fund, its economy should grow by 9.9%.

It’s not the same story for consumers and households. Due to falling spending power, inflation is likely to rise to 30%.

Graphic: Turkey economic confidence https://fingfx.thomsonreuters.com/gfx/mkt/zdpxonggrvx/turkey%20confidence.PNG

7. IN THE BANCK

When times are difficult, Turks in the country and local businesses tend to convert their liras into euros and dollars.

The currency has not changed much in recent months. The domestic deposit base has a dollarization rate of over 60%. A real crisis could occur if Turks start pulling money from banks.

Graphic: Forex held by Turkish local individuals and institutions https://fingfx.thomsonreuters.com/gfx/mkt/akvezmxlapr/forex%20held%20turkish.PNG