Turkey’s Serial Siege Sendoffs

The Turkish lira has lost 20% of its value this year and continues to hit all-time lows as inflation remains near 12% and foreign exc

hange reserves dwindle. The economy contracted 9.9% y/y in Q2.  The trade deficit for the first 8 months of the year surged 69% over the same period in 2019. Imports in August alone rose 21% y/y as Turkish citizens went on a gold buying frenzy, searching for an investment that that will hold its value against inflation. Gold has long been a safe haven for Turkish savers at times of economic, market, and political instability. The trade deficit has pressured the perennial current account deficit already suffering from a widening services deficit on lack of tourist receipts due to the pandemic. To fund it and the budget deficit foreign portfolio inflows have dwindled to record lows, w local debt ownership now less than 5%.

Fitch Ratings has warned that Turkish banks’ underlying asset quality will weaken due to the pandemic but noted that reported non-performing loans will be “flattered” by regulatory forbearance and loan growth.  Lending surged in H1 – 16% in FX-adjusted terms, according to the rater – driven by both Treasury-backed Credit Guarantee Fund loans to SMEs (sp) and retail demand post-lockdown.  Banks are also contending with balance sheet risks from FX lending as the lira sinks.  The central bank, meanwhile, has reportedly almost reached its set limit for Treasury funding after earlier doubling the ceiling to 10% of its balance sheet. 

In geopolitics, the European Union is threatening Turkey with sanctions for its “confrontational actions” in the escalating standoff with Greece and Cyprus over hydrocarbon resources in the Eastern Mediterranean.  French President Macron, along with the 6 other EU “Club Med” leaders, met to discuss the growing territorial tensions which have further derailed Turkish-EU relations already strained over its policy in Syria, military intervention in Libya, and jailing of opponents of President Erdogan. Unless negotiations with Athens resume, the EU is likely to decide on sanctions later this month.

 Longtime Turkish analysts and investors agree the intertwined political, economic, financial sector, and currency situation is nearing a breaking point.  Lack of central bank independence to raise rates to protect the currency also weighs on sentiment, with investors staying away while the benchmark rate is 8.5% on 11.8% inflation. Erdogan’s son-in-law, The Treasury and Finance Minister, insists that the government wants to ensure the lira is competitive to boost exports and narrow the current account gap, but inflation and metals imports spiked as a result. Turkey’s growing alienation from EU and NATO allies at the same time the economy and currency are melting down and banking sector stress grows may finally force a government rethink about more conventional stabilization policies. Technocrats were once able to wow banks and fund managers and win their confidence on monetary policy and bank regulation, but such a shift now is in the hand of family leadership and business/political allies.   

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