Turkey could be set to follow the Argentine government in seeking financial aid from the International Monetary Fund if it is to avoid a deep recession, analysts said.
High levels of dollar and euro debt, a weakening currency and elevated oil prices are making investors increasingly nervous. A poll commissioned by Bloomberg also added extra political uncertainty to the mix, suggesting President Recep Tayyip Erdogan may not win a majority in parliament in the June 24 election.
The Turkish lira slid June 13, falling as much as 2.1% to 4.69 to the dollar before recovering to trade down 0.9% by 11:06 a.m. ET. The price of Turkey's 5.125% dollar bond due in 2028 fell to 87.25, from 98.75 on Jan 10, as the yield hit 6.96%.
Part of the pressure on Turkish and other emerging market assets has come with the end of a period of historically low interest rates in developed economies. The Federal Reserve was expected to raise the federal funds target rate by another 25 basis points later June 13.
But the latest volatility, which came despite 425 basis points in central bank interest rate rises since late May, could have been sparked by the poll, with the potential of a hung parliament and prolonged political uncertainty making the market more skeptical that Turkey will be able to address structural issues with its economy, said Paul McNamara, investment director at asset management group GAM.
"The biggest issue is debt. Turkey’s had a very successful growth record, but in recent years that’s been driven by an accumulation of foreign debt. As the lira depreciates its harder to service that debt," McNamara said, adding that he would be cautious about the methodology of the poll.
Turkey’s current account deficit in January-April ballooned to $21.8 billion, up from a $12.1 billion deficit in January-April 2017, as the president continues to pursue a credit-fueled growth policy. This yielded GDP growth of 7.4% in the first quarter, according to the Turkish Statistical Institute, but annual consumer inflation rose 1.3 percentage points in May to 12.2%.
In its outlook for the second half of the year, Société Générale said the lira was likely to continue to depreciate against the dollar if Erdogan retains the presidency with a nationalist AKP-MHP parliamentary majority.
"The outcome of the general elections will be crucial in determining whether Turkey reorients itself toward structural reforms, normalizes its relationship with Western counterparts, adheres to conventional economic and monetary policies, and successfully tackles accelerating inflation. Continued fiscal loosening may strain Turkey’s fiscal anchor."
'Interest rates cause inflation'
Investors have also been unnerved by comments from the Turkish leadership. A mid-May meeting between Erdogan and fund managers during a three-day trip to the U.K. backfired when he expounded on his theory that high interest rates cause inflation.
Erdogan's senior economic adviser Cemil Ertem once again defied traditional economic wisdom June 13, arguing in the Turkish newspaper Daily Sabah, that "the relationship between rapid growth acceleration and inflation is marginal."
Timothy Ash, emerging markets strategist at asset management group BlueBay Asset Management tweeted in response, "This kind of stuff just does not help market sentiment. Actually we have a crisis of confidence in Turkey, post Erdogan's London trip. Might end up needing an IMF program post-election, to shore up confidence."
McNamara agreed that prolonged dollar strength and poor economic management could see Turkey’s new government follow Argentina in seeking assistance from the Fund.
"Politically it is more difficult [than for Argentina] but the idea that Turkey will need a bailout is not far-fetched … If the alternative is a major crash and huge recession, then you have to avoid it," he said.
As was the case with Argentina, inflation is sapping sentiment. This has been made worse by Erdogan's pressure on the central bank not to raise rates. Eventually, faced with a run on the lira, the benchmark rate was raised to 17.75%, more than many analysts had considered necessary to restore confidence.
Any talks with the IMF are likely to be more strained than those with the authorities in Buenos Aires, where President Mauricio Macri has repaired the country's previously rocky relationship with the Fund. The IMF made the independence of the country’s central bank a key component of Argentina's $50 billion bailout. However, Erdogan has said he would exert greater power over central banking if he were to be re-elected later this month.
But a call for help to the Fund's Washington headquarters may be unavoidable. Foreign reserves in Turkey declined to $106.6 billion as of June 1, according to the Central Bank’s Weekly Monetary and Banking Statistics, down from $116.1 billion in mid-February, a rate that may accelerate if the lira continues to weaken.