By Guney Kaya
With weak Turkish economic outlook and failed attempts to cultivate investor interest in the Turkey, we expect continued declines in the Lira’s future.
Turkey Needs Cash
Since the 1980s, the Turkish economy has been highly dependent on foreign credit. The economy is built around the need for consistent foreign cash flow, and any hitch causes major economic problems just like it did last summer, where the Lira depreciated by more than 40%. As the municipal elections end (other than Istanbul’s), Erdogan’s government is desperately trying to lure investors for inflows to boost the economy and increase growth while trying to heal the wounds of the Lira Crisis. The desperation comes from the fact that the Central Banks reserves drastically decreased in the last month by $5 billion, leaving Central Banks immediate reserves on $26.9 billion only. Investors are justifiably worried since Turkey has obligations to pay $118 billion in the next 12 months.
Albayrak and his team travelled around trying to assuage investor concerns, presenting policies to better the Turkish economic situation. Investors were unconvinced, however, by his weak assurances that a depreciated Lira would sustainably reduce the trade deficit. They were also unimpressed by the newly initiated infrastructure projects that promised little profit and seemed to only be in place to reduce unemployment, contributing further to inflation fears.The investors, seconded by Moody’s, demanded high yields on their credit. With yet another failure as minister, Albayrak, already seen as a nepotistic choice of minister, continues to lose credibility and agency over the state of the Turkish economy.
Inflation, another serious economic problem for which no healthy solution has been implemented, has been rising rapidly after the Lira Crisis. On October Consumer Price Index peaked at 25.24% which was the highest in 15 years. Despite the radical measures of The Erdogan government, it only lowered to 19.71% in March on a year over year basis.
Inflation is the greatest in food, especially fruits and vegetables. Consequently, the government decided to take some concerning countermeasures, beginning with removing the tariffs on vegetables, highly damaging the local producers, and threatening corporations with high vegetable stocks in their warehouses to force them to sell at sub-market prices. Additionally, the government imported a massive amount of these vegetables and started selling them at a loss through tents built on the streets with a quota per person, which ended up in scenes like Venezuela and East Germany. Were it not for these unsustainable and totalitarian anti-inflationary policies, inflation would be substantially higher than the published data. In the long run, these countermeasures that not only introduce competition from better facilitated foreign actors but also directly undermine the competitiveness of the local businesses, will damage the prospects of local businesses and drive Turkey further into a situation of trade deficit and consequent Lira decline.
Furthermore, aside from the anti-inflationary countermeasures, the inflation itself has a negative effect on Turkish companies, compounding the problems in capital markets started by the Lira crisis. Car producers took the biggest hit as car sales decreased by 59% from last year leading to substantial layoffs. Real estate is also struggling as real estate valuations slid dramatically against the USD. Real estate valuations sharply decreased in dollars as lira bottomed out.
Due to inflation induced headwinds in the capital and consumer markets, as well as the direct currency impact of inflation, the Lira could very well see further declines.
Rising Cost of Debt and Turkish Eurobonds
With Turkey’s struggles to find cheap debt, they’ve been left looking to the Eurobond markets to mitigate investors’ concerns with the Lira. Turkey Issued more than double the amount of Eurobonds YoY, saddling turkey with a huge debt burden at a substantial 7.625% coupon rate, 50% greater than the rate on last year’s Eurobonds. Although the Turkish economy does not look very promising lately with the recent crisis and fundamental problems, investors have eaten up these high-yielding Eurobonds, with the issue being oversubscribed by 2.6 times. Lately, even the Turkish citizens have been choosing Turkish Eurobonds to their conventional investment plans, as they are promising very high yield.
This is because the Turkish Eurobonds may not be as dangerous as the credit rate of Turkey suggests. Though, there are plenty of economic indicators that look negative. Turkey still has the IMF card to play in the case of another currency crisis. Turkey’s debt is still not too high compared to its GDP. Even though it’s leveraging itself now, Turkey’s gross external debt to GDP ratio is less than most of the European countries at only 57.5%. However, with the rising levels of Turkish debt, as well as the weak economic situation, the ratio may end up rising faster than expected.
The weakening has Lira significantly decreased imports by 21.45% in the first quarter of 2019, with exports have increasing by 3.34% in the same period. Turkey’s negative trade balance shrank in 2018 October and stayed in the moderate levels even after Lira increased against the global currencies.
The decreasing trade deficit may seem promising for Turkey as they have been struggling with growing negative trade balance for a long while. However, this relief maybe be unsustainable as it is brought on by producers using their current stocks, which will finish eventually leading exports to increase.
The Play: Opportunities Come with Risk
In conclusion, the economic situation looks uncertain, but the Turkish economy is still not chaotic enough to predict default in the foreseeable future. Turkish currency is highly volatile and investing in Turkish Lira bears high risk. The Turkish currency has been depreciating since the beginning of February and it is likely that with rampant inflation and weak economic outlook that this will continue. Additionally, there are plenty of other threats to the Lira which might compound its decline such as regional problems, disputes with the USA due to S-400 Russian missiles and Erdogan’s radical speeches and municipal election renewals suggesting consolidating totalitarianism. Although Lira looks powerless and a Lira short may seem reasonable, be aware that shorting Lira comes with considerable risks as Central Bank tends to take radical measures in extreme situations. Firstly, we saw a 625bp increase at Central Bank Rates during the last Lira crisis. Moreover, the Central Bank tightening liquidity before the elections caused the overnight swap rates to jump to 1000%, as investors wanted to short Lira just before the Municipal elections, betting on political instability.
Turkish Eurobonds may be a more interesting alternative than FX trades for investors seeking a medium risk fixed income issue. On the other hand, investing in Turkish companies and real estate should be avoided, even though Turkish stocks are appealing with very low book ratios and real estate is on discount with the weak lira.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.