Recep Tayyip Erdoğan’s strong showing in Sunday’s election has prompted rating agencies to warn of a fresh sell-off in the lira if the Turkish president continues his “unsustainable” economic policies.
Turkish assets have sustained a blow after Erdoğan beat his rival Kemal Kılıçdaroğlu in the first round vote, heightening his chances of prevailing in a May 28 run-off. The cost to insure Turkey’s debt against default has jumped over the past two days, with the “spread” on five-year credit default swaps rising to 646 basis points from 506bps on Friday.
The selling in Turkish assets came as investors reversed bets that Kılıçdaroğlu, who led in pre-election polls, would bring Turkey back to a conventional economic policy, undoing a patchwork of programmes that have been put in place under Erdoğan’s leadership.
Concerns are mounting of more pain to come if Erdoğan secures a new mandate and presses on with a number of unorthodox policies, including his insistence on maintaining low interest rates to cure inflation running at more than 40 per cent.
“Another term for President Erdoğan would likely imply a continuation of the current unorthodox and unsustainable policies and macroprudential measures with a heightened risk of persistent very high inflation and severe currency pressures,” said Moody’s Investors Service, the credit rating agency.
Erdogan’s government has deployed a range of unconventional measures to stabilise Turkey’s $900bn economy, including tight controls of companies’ transfers of foreign currency and the 2021 launch of special savings accounts to protect depositors from lira fluctuations.
These tools have helped slow the lira’s fall, although the currency is still trading near a record low at TL19.67 to the dollar.
But many analysts say the lira remains overvalued, in part due to these measures and a prolonged effort by the central bank to prop up the currency. The lira has fallen about 60 per cent against the dollar over the past two years.
Turkey’s large current account deficit, which hit a record $24bn in the first quarter of this year, was also a “big issue”, said Erich Arispe, a senior director at Fitch Ratings, another of the leading credit rating agencies.
Arispe said Turkey would need to “find . . . billions of dollars” to finance the yawning deficit, something that may be achieved in part by continuing to tap into its dwindling stock of foreign currency reserves.
Net foreign assets, a proxy for the size of Turkey’s foreign currency war chest, have declined to minus $13bn from $1.4bn a year ago, according to central bank data collated by the Financial Times. Those figures include billions of dollars in funds borrowed from the domestic banking system through short-term lending tools known as “swaps”.
Arispe said that pressure on international reserves had been “significant in recent weeks” as the government took a pro-growth approach ahead of Sunday’s elections.
HSBC also indicated on Monday that Turkey’s current account deficit was one of its main “vulnerabilities”. The bank said April trade data suggested there was “no sign an improvement is under way in the near-term”.
“Such a sizeable deficit, mostly financed via [a drawdown in reserves] is unsustainable and should be reflected via a weaker lira,” HSBC said in a note to clients. The bank said it expected the lira to tumble to 24 to the dollar by year-end, marking a 18 per cent decline from current levels. However, it said it also cannot rule out a deeper slide to 27.
Barclays analyst Ercan Erguzel added that he expected the current account deficit to hit about $40bn in the next 12 months. Turkey would need about $30bn to finance it when excluding funds coming from unknown sources, known as “errors and omissions”.
“Turkey may use its gold reserves ($15bn) and get additional help from friendly countries ($15bn). However, it looks a very delicate balance to us,” Erguzel said.
