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Turkey central bank hike may be too little, too late

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Turkey central bank hike may be too little, too late

A relief rally in the Turkish lira went violently into reverse May 24 as analysts questioned whether an emergency 300-basis-point rate hike was too little too late.

The Turkish currency had plunged 4.4% to 4.7896 by 10:20 a.m. ET, resuming a slide toward 5 to the dollar as investors focus not only on the country's large current account deficit at a time of rising U.S. yields and more expensive oil but also on President Recep Tayyip Erdogan's unorthodox economic views. The sharp depreciation ended a dramatic rally after the Turkish central bank raised its late liquidity window interest rate to 16.5% from 13.5% on May 23, sending the currency whipsawing 2% higher after having fallen more than 5% earlier in the session.

"Investors remain concerned given inflationary pressure, an imbalanced external position, pressure on the fiscal accounts as well as geopolitical tensions amid a weakening macro backdrop," ING sovereign debt strategist Trieu Pham said in a research note. With inflation set to hit 14% in the summer, the emergency hike only takes real rates to 2.5%, still lower than the 3% to 4% available from other high-yield emerging markets, said Chris Turner, another ING analyst.

"Some would argue that's not enough for an economy running a 5% current account deficit and the exposure to FX borrowing and energy ... We would say at least this shows policymakers are prepared to act decisively and that there is a limit to [central bank] tolerance of [lira] weakness," Turner wrote.

The lira has depreciated 20% so far this year, a decline exceeded only by that of the currency of Argentina, which was forced to seek an International Monetary Fund bailout earlier in May. Rising U.S. rates are putting pressure on overextended borrowers around the world, including emerging-market economies with heavy reliance on foreign funding.

Political pressure

Turkey's current account deficit is the largest among systemically important emerging markets, and its dependence on imported oil leaves it exposed as crude prices rise, according to TD Securities. The country's nonfinancial corporate sector saw its debts rise to the equivalent of 67.4% of GDP by the third quarter of 2017, up from 44.8% in 2012, Bank for International Settlements data shows. It also has one of the highest ratios of short-term external debt to GDP of any emerging market, at 13%, according to TD Securities' head of emerging markets strategy, Cristian Maggio, who said he expects the central bank to hike by another 100 basis points at its next official meeting June 7.

Investors have also been increasingly unsettled by the pressure exercised on the Central Bank of the Republic of Turkey by the president, who argues that raising interest rates cause inflation. Erdogan, whose government has become increasingly authoritarian since a failed coup against him in 2016, has called snap elections for June 24.

"As long as Turkey's political rulers espouse unorthodox economic theories and attempt to influence the conduct of monetary policy at the CBRT, we believe that Turkey will find itself trapped in this recurring nightmare of high interest rates, high inflation, collapse of investor confidence, currency crises, and reactive central bank policy-making," Phoenix Kalen, a fixed-income analyst at Société Générale, said in a research note.

It is possible that the lira's travails might have damaged Erdogan's chances in the June 24 elections, Kalen said, adding that if the opposition were to win the presidency, it would spark a "phenomenal rally" in the lira.

The central bank only acted after pressure on the currency had become so great that some analysts were speculating Turkish authorities might be forced to enact capital controls. Economic growth will likely fall to 3% to 4% this year, about half 2017's level, Maggio said in an interview, noting that it would be concerning if Erdogan were to attempt to counteract the effect of the rate hike by applying more fiscal stimulus in an attempt to win over voters. The president recently produced corporate tax cuts worth 135 billion lira.

Lenders in Turkey already expect a wave of nonperforming loans from their business customers, many of whom have debts in dollars or euros, if the currency's value does not come down below 4.5 lira to the dollar, said a banker with a large retail group in Turkey who requested anonymity.

No bailout

Larger Turkish corporate holdings have approached creditors about loan restructurings, S&P Global Ratings said in a May 1 report in which it lowered Turkey's foreign currency rating to "BB-/B" from "BB/B."

Yet, while Turkish companies are coming under pressure, Turkey is unlikely to follow Argentina into needing a bailout or struggling to pay its debt, said Richard Briggs and Fernando Barajas at CreditSights. Turkey's gross public debt was 28% of GDP in 2017, compared to Argentina's 53%, and its net government borrowing requirements were a third of the Argentine level, at 2.3% of GDP, IMF data showed.

"In the event of IMF support, which seems unlikely to be requested prior to the elections, if at all, Turkey is very unlikely to have to seek debt reduction," Briggs and Barajas wrote, noting that only 40% of sovereign debt is in foreign currency.

Even without corporate defaults, the depreciating lira eats into companies' profit margins, Ugras Ulku, deputy head of EM Europe Research for the Institute of International Finance, said in an interview. So far, Turkish banks have not had problems rolling over their short-term debt, but in a tightening monetary environment, that could change, Ulku said.

In the first quarter, Turkish banks borrowed about $1 billion; since the end of March until May 2017, they borrowed another $1 billion, according to Turkey's bank regulator.

"I'm concerned now, but I'll get more concerned if I see roll-over ratios go down significantly below 100%," he said. "That would mean some sector could not access as much foreign funding as they need to roll over the maturing external debt."

This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings, a separately managed division of S&P Global. Descriptions in this news article were not prepared by S&P Global Ratings. The original S&P Global Ratings documents referred to in this news brief can be found here.