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Turkish lira suffering and could get worse [CINKCIARZ.PL ANALYSIS]

Not long ago, many elements indicated that Turkey is in for a relatively steady GDP increase in the coming years. However, the most recent sudden political events in this country have dramatically changed its economic perspectives. The exchange rate of the Turkish currency depreciated to its lowest level in history. Moreover, it seems that it may get worse. Marcin Lipka, Cinkciarz.pl analyst, presents possible scenarios for this situation.

Up until recently, Turkey was considered a prime example of an emerging market. The GDP growth at the level of 3-4% per year was mainly fueled by internal consumption. According to the IMF estimations, this pace of development was supposed to be sustained at a similar level until 2020. However, Ankara's problem was that the GDP growth was accompanied by a relatively high inflation (7-8% per year). Anxieties were also caused by increasingly frequent terrorist attacks that decreased the tourism income. The necessity of supporting approximately three million refugees from Syria was a significant burden as well.

A high deficit on the current account has been a problem for Turkey for many years. In the past few years, it was at the level of approximately 5% of the GDP (approximately 35 billion dollars). Moreover, its forecasts did not indicate a quick reduction. However, this deficit was relatively easy to finance due to the inflow of financial investors who were encouraged by high interest rates.

A conservative policy regarding budget has always been a strong side of Turkey. Deficit of public finance was never higher than 2% of the GDP per year. Moreover, in the past six years the debt to GDP relation decreased from 42% to 33%. This was one of the reasons why two out of three of the largest rating agencies (Fitch and Moody's), have continued to increase Turkey's loan credibility to investment level. Relatively high currency reserves were positively received as well. These are worth more than 110 billion dollars, which equal the value of eight months of import.

Economic consequences of the coup de’état: depreciation of lira and tourism market crisis

We could expect negative economic consequences from the coup attempt this past weekend. However, Turkey is particularly sensitive to political disturbances. Currently, a high deficit of the current account will need to be financed by inflow of wallet capital almost in its entirety. It is difficult to expect that direct foreign investments would appear in the current situation. This is because the transferring of production, as well as services to Turkey is currently too hazardous for most companies.

There is also no doubt that difficult times are ahead the tourism industry. We can tell this by the data regarding the balance of the current account that was published by the central bank. A surplus to the amount of 27 billion dollars from 2014 included the 24 billion earned by the tourism industry. In 2015, the result was three billion dollars lower. During the first five months of 2016, the surplus only amounted to four billion dollars, while at the same time last year it equalled six billion dollars. When the holiday season is at its heights, we may expect the inflow of foreign currencies for the tourism industry to decrease by more than a half - approximately 15 billion dollars.

With the lack of foreign investments and a significant decrease in income from tourism, the government will be forced to increase public expenses in order to stimulate economic growth. This action may have a negative impact on the relation between debt and GDP and it may increase the costs of financing the budget deficit.

It is also likely that the current administration will try to reduce the negative balance of foreign trade (approximately 50 billion dollars). The easiest, as well as the fastest way, to achieve this is to wear-off the Turkish lira (TRY). This will decrease the demand for imported products. At the same time, this will increase the competitiveness of Turkish products. As a result, the deficit should decrease significantly as well.

If Ankara succeeds in maintaining control over the economic processes, a decrease in value of the lira should not exceed the limit between the treasury bond rates between Turkey and the developed markets. Such a controlled decline would allow Turkey to remain attractive to foreign capital. This means that a decrease in value of the lira against the euro or the dollar should not exceed 10% in a year on year relation. This is regardless of the shock this week that brought the Turkish currency to the lowest level in its history against the dollar.

As a result, exchange rate of the dollar should not exceed 3.30-3.40 TRY and the euro will most likely remain below the level of 3.70 TRY in the forthcoming months.

Pessimistic scenario

The above assumptions may quickly lose validity if it appears that the political situation is reeling out of control. The three-month state of emergency that was implied Wednesday evening is causing internal and external repercussions. There are speculations regarding a possible implementation of capital flow control. Despite the definitive denial from the authorities, investors are aware that blockades in free capital flow are never announced in advance.

It's worth keeping in mind that relations between Turkey and western countries are becoming increasingly tense. A lot of worldwide media outlets were quoting a telegram from the Reuters agency. It presents a statement from, “a former army officer.” He is wondering why the coup initiators didn't shoot down the president's airplane since they had it at a gunpoint. This quote increased speculations that the coup attempt was the work of Turkish authorities.

A statement from John Kerry may cause anxieties as well. The American state secretary said that, “NATO's requirement is to respect democracy.” The Washington Post wrote that this statement was a peculiar warning. It indicates that, “in the forthcoming days, NATO will evaluate Turkey in order to make sure whether it fulfills the organization's requirements concerning the respect of democratic reigns.”

If foreign investors claim that there is a real risk that Turkey will end its alliance with the western countries and the speculations regarding the control of capital flow continue to grow, a reduction of the value of the lira may spin out of control. With this scenario, any estimates of any level regarding the lira against the euro, as well as the dollar, are practically impossible.


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