Fitch: Turkey’s Actions Are Insufficient To Restore Policy Credibility

To contain the historic plunge of its currency, this week Turkey unleashed an unprecedented barrage of interventions in its market, if not the economy, mostly focusing on crushing short sellers and making shorting the Lira by speculators prohibitively expensive.  In fact just moments ago, the Turkish banking regulator launched yet another intervention:

  • *TURKEY EXPANDS LIMITS ON FX SWAPS TO SOME LIRA FORWARDS

The one thing Turkey did not do, is despite vague promises of fiscal reform and monetary stabilization, it continues to refuse to do the one thing investors across the globe demand: raise rates and tighten financial conditions.

Confirming that this is the missing link, in a report this morning, Fitch said that Turkey’s incomplete policy response to the lira’s depreciation “is unlikely on its own to sustainably stabilize the currency and the economy.”

The rating agency, which one month ago downgraded Turkey to BB outlook “negative’ with more downgrades set to come, said that it believes “this would require an increase in the policy credibility and independence of the central bank, tolerance of weaker growth by policymakers, and a reduction in macroeconomic and financial imbalances.”

None of those are forthcoming as a result of Erdogan’s stongman tactics.

Meanwhile, in further pain for the Turkish economy, today the lira resumed its slide after a Turkish court rejected an American pastor’s appeal for release, drawing a stiff rebuke from President Donald Trump who said the United States would not take the detention “sitting down”.

“They should have given him back a long time ago, and Turkey has in my opinion acted very, very badly,” Trump told reporters at the White House, referring to Brunson. “So, we haven’t seen the last of that. We are not going to take it sitting down. They can’t take our people.”

It was not immediately clear what additional measures, if any, Trump could be considering. U.S. Treasury Secretary Steven Mnuchin told Trump at a cabinet meeting on Thursday that more sanctions were ready to be put in place if Brunson were not freed.

And as traders once again sold off the Lira, they pushed the return on the Turkish currency down to 37%, making it tied with the Argentine Peso for worst performing currency of 2018.

Fitch: Turkey's Actions Are Insufficient To Restore Policy Credibility

What happens next? Well, as Fitch explained in its detailed note, absent Erdogan folding and conceding his “new economics” have been wrong, the Lira will continue to suffer until eventually Fitch – as well as S&P and Moody’s – all downgrade Turkey to junk and below as its economic unraveling becomes unfixable.

Below is the full Fitch text (link):

Turkey Moves Insufficient to Restore Policy Credibility

The Turkish lira recovered somewhat this week after falling below TRY7 to the dollar, but is still down around 35% against the dollar in the year to date. Foreign exchange reserves (including gold) dropped to USD96.8 billion at end-June from USD110.4 billion at end-April.

The Central Bank of the Republic of Turkey raised the effective interest rate by 150bp through providing liquidity at the overnight interest rate of 19.25% rather than the main one-week repo rate of 17.75% and reduced reserve requirements to provide an additional USD10.7 billion of liquidity for domestic banks. The banking regulator has also restricted lira short-selling. On Thursday, Treasury and Finance Minister Berat Albayrak reiterated the goals of reducing inflation and the current account deficit, maintaining fiscal discipline and structural economic reform.

Efforts to fill the initial policy vacuum have helped stabilise the lira, as has a pledge from Qatar to invest USD15 billion in Turkey, although details and timing of the investment have not been disclosed. Albayrak ruled out capital controls on Thursday, and we do not believe these are likely as Turkey needs to attract large capital inflows. Nor do we believe Turkey will seek an IMF programme, unless the situation worsens materially, as this would be politically unpalatable.

However, an ad hoc and incomplete policy response cannot fully address the underlying causes of the lira’s fall, namely the large current account deficit and external financing requirements, the jump in inflation (to 15.9% in July), the build-up in foreign currency debt, and deterioration in economic policymaking credibility. These expose Turkey to a more challenging global financing environment, including a stronger US dollar, rising US interest rates and trade tensions, and a deteriorating political relationship with the US. Heightened risks to macroeconomic stability and the challenges of engineering an economic soft landing were key reasons why Fitch downgraded Turkey’s sovereign rating to ‘BB’ from ‘BB+’ and assigned a Negative Outlook on 13 July.

Bilateral support such as that pledged by Qatar is unlikely to meet Turkey’s external financing requirements without a sustainable policy adjustment. We estimate Turkey’s gross external financing requirement at USD229 billion in 2018 (including short-term debt), well in excess of official foreign exchange reserves.

In Fitch’s view, evidence of an appreciation of and genuine commitment to orthodox monetary policy from the top of the Turkish administration, and greater detail on policy measures in the new administration’s economic agenda, plus a track record of implementation, are likely to be required to restore lasting market confidence. Markets appear to believe that only a further increase in the main policy interest rate (which has already been raised by 500bp since April) would establish a sufficient real rate reflective of the risk premium, demonstrate policy credibility, support disinflation, re-establish a nominal anchor and attract capital inflows.

The abrupt tightening in financial conditions will sharpen the slowdown in GDP growth already under way. A slowdown from 2017’s unsustainable 7.4% growth and some depreciation of the real exchange rate were inevitable to reduce imbalances. Turkey’s vibrant economy and favourable medium-term growth potential support sovereign creditworthiness, as does low government debt (28% of GDP at end-2017, of which foreign-currency debt was only 11% of GDP). But the absence of an orthodox monetary policy response to the lira’s fall, and the rhetoric of the Turkish authorities have increased the difficulty of restoring economic stability and sustainability.

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