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Turkey: lira plunges to record low over US sanctions, threatening further macro balances

Published

2018

Tue

14

Aug

GDP forecast 2018: 4%
Coface Country Risk Assessment: C (high)
 
 
What
The United States has announced that it will impose sanctions on Turkey’s Minister of Justice and Minister of the Interior in retaliation to the detention of American pastor Andrew Brunson for terror-related charges. Following the announcement, the Turkish lira slumped to a record low of TRY 5.09 versus USD 1. The United States stated that it has blocked the ministers’ properties in their country, and has prohibited US citizens from engaging in transactions with them.
 
Why
1) Pastor Brunson is accused of being involved with the movement of Fethullah Gulen, the U.S.-based cleric who Turkish authorities say masterminded the coup attempt in 2016 in which 250 people were killed and the outlawed PKK. He is also accused of espionage. After being held for 21 months, Mr Brunson was transferred to house arrest late in July. His appeal to be released from house arrest has been rejected.
 
2) However, Mr Brunson’s case is not the only problem between the United States and Turkey, with the relationship of the two NATO allies remaining multidimensional. Turkey and the United States maintain defend different positions over issues such as the militant group PYG in Syria, Cyprus, Iran’s sanctions and Syria. The United States has also threatened Turkey with sanctions for the latter’s plan to buy Russia’s S-400 air defence system. The Brunson case seems only to be further deepening the rift between the two countries.
 
Turkish officials said they would retaliate against the United States over its decision to impose sanctions, indicating Turkey will not back down. The foreign ministry said it would take an “equivalent” response to the “aggressive” decision of the US.
3) Rising political tensions have pushed the lira further down. The ailing currency hit its weakest-ever level of 5.09 versus the US dollar from 4.92 a day earlier. The lira has lost 34% of its value against the greenback since the beginning of the year. The Istanbul stock exchange, BIST, tumbled more than 2.5%.
 
4) Turkey’s five-year credit default swaps (CDS), the cost of insuring exposure to Turkish debt, rose by 16 basis points from a day earlier to 346 basis points – a 6.5 year high.
 
Risks
The lira’s free fall will put further pressure on the country’s macro dynamics and the private sector.
1) The central bank sharply raised its inflation forecast for 2018 to 13.4% (up from 8.4%) and for 2019 to 9.3% (up from 6.5%) due to the impact of the lira’s free fall since the start of the year. Consumer prices hit 15% in June while producer prices jumped to an all-time high of 23%. Coupled with the new price hikes on electricity and some food products, inflation will continue to increase and hit record high levels. There could be upward pressures on our yearly average inflation estimate of 13.5% and 15% for 2018.
 
2) Due to the rising inflationary pressures, the central bank has hiked its rates by 500 basis points since April. However, current depreciation is not entirely related to the monetary policy’s impact zone. This situation suggests the lira is subject to further weaknesses.
 
3) The import dependence of the Turkish economy in terms of intermediate goods results in higher production costs for the corporate sector during periods of weak local currency. In addition, funding costs are also increasing in line with higher policy rate of the central bank. Interest rates on individual loans rose to 25% recently, up from 15% early in 2017, and rates on commercial loans to 24% (up from 14%). All sectors will likely be hit by higher funding and input costs. However, those driven by domestic demand and with a higher degree of import dependence (such as retail and ICT) will be more affected. Other exporting sectors such as automotive, agri-food, textile, and clothing will have the opportunity to partially compensate partly their losses in the domestic market via export revenues.
 
4) The Turkish economy is set to face a slowdown in the second half of the year. Until recently, chances were high for the latter to happen in the form of a soft landing. Nevertheless, tougher financial and monetary conditions, lower domestic demand, a highly indebted private sector and the need to roll over a total external funding of nearly USD 220 billion within a year may result in a hard landing.  
 
Source: Coface
 
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