The Daily Update - Lira Lockdown

Over the past 3 days Turkey’s overnight swap rate has gone from ~23%, to 100%, to 360%, to touch above 1,300% earlier today. This, along with direct interventions in the currency market looks to be enough, for now, to stave-off short sellers and carry traders exiting ahead of this weekend’s local election – seen as a proxy for Erdogan’s authority. Many were expecting a repeat run on the currency in the days leading to the election, notably with JPMorgan urging investors to sell the lira last week, causing the currency to fall as much as 7% intraday last Friday. But just as Turkey investigates JP Morgan for market manipulation, Erdogan has reminded investors that they themselves are ever ready to manipulate the currency, and have more than unwound last Friday’s lira weakness with such unprecedented intervention.

Some are describing the liquidity crunch as “taking a page of the Chinese currency manipulation playbook” accounting for a comparable degree of state influence over the banks; but the salient difference being the TCMB (Turkey’s central bank) has far less ammunition than the PBoC in terms of FX reserves. The TCMB had already been perceived to be propping up the lira pre-election following data last week that it had drawn-down on foreign exchange reserves. Reserves fell $6.3bn in the first fortnight of March to just $28.5bn, far beyond the $3.8bn in hard currency debt that was due, with the discrepancy most likely down to absorbing lira outflows (note that the often quoted official reserve figure uses Turkey’s calculations, which include institutional deposits with the central bank, despite the TCMB having no legal way to make use of them).

Last September Turkey’s official interest rate was raised to 24%, tempting the market into lira both with the high rates but also seeing the move as a sign of the TCMB’s independence in opposing strongman Erdogan’s calls for stuffing the economy with cheap credit. It was enough to allay fears from the country entering recession and the accompanying 50% depreciation in the currency up until August that year. For the seven months since then it has certainly been a good trade, with the lira being the strongest appreciating emerging market currency (though still below earlier 2018 levels) which compounded with carry has yielded 30-40%. But these interventions are trapping foreign investors in a now questionable position. Once the elections have run their course and assuming Erdogan is seen to come out on top (but even if not) the country will have to begin uncovering all the NPLs it’s been hiding, bring the swaps market back towards some normalised level and be more careful to use its international reserves more sustainably. And although banks’ foreign lending has, since the 2018 rout, been limited to 25% of equity the lira’s fragility to an eventual speculative attack will increasingly be a concern.

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