Turkey: Outlook Remains Bearish
By Win Thin
Some developments in Turkey today are worth noting. The central bank left the 1-week repo policy rate steady at 5.75%, as expected. The bank made some optimistic comments on inflation, current account, and loan growth, but none of them were grounded in reality. The fact of the matter stands that inflation is rising, the current account gap is widening, and loan growth is still way too high. Policy needs to be tightened, period. It said it would continue to use the rates corridor to control liquidity, but we do not think that is enough.
Recall that at the October meeting, the central bank hiked the overnight lending rate from 9% to 12.5% and the late liquidity borrowing rate from 12% to 15.5%, thereby adjusting the so-called rates corridor. These hikes were meant to tighten liquidity by raising the cost of borrowing from the central bank, but what’s needed to restore central bank credibility is a more pronounced orthodox tightening in monetary policy. And yet policy-makers are not yet ready to do this.
In related news, Fitch cut the outlook on Turkey’s BB+ rating to stable from positive, citing near-term risks to macroeconomic stability. It noted challenges from the current account and inflation, but affirmed the rating and said it is supported by “favorable” debt dynamics. Our own sovereign ratings model has Turkey moving back to BB+/Ba1/BB+ in the upcoming Q1 2012 report, down from a borderline BBB-/Baa3/BBB- implied credit in Q4 2011. This compares to actual ratings of BB/Ba2/BB+. As Fitch was the highest of the three, this move will disappoint those looking for investment grade. The fundamental story has turned more negative in recent months, and so lack of an adequate policy response by Turkey is coming back to bite them.
We note that during the 2008-2009 EM selloff, TRY was one of the worst at -31% vs. USD vs. worst performers PLN (-43%), HUF (-39%), RUB (-34%), MXN (-33%), BRL (-33%), and KRW (-32%). It is holding up slightly better since September 1 2011, -8% vs.USD vs. worst performers ZAR (-18%), HUF (-17%), PLN (-13%), MXN (-13%), BRL (-13%), and INR (-12%). However, given continued policy mistakes, we think TRY will revert to form and become one of the worst performers again during this current sell off. The October high of 1.9096 will likely be tested and broken. USD/TRY is trading in an upward sloping channel dating back to January, with the top around 1.9756 and the bottom around 1.7683. Right now, TRY is near the center of that channel but given external and domestic developments, we think it trades towards the top rather than the bottom.
The central bank intervened aggressively in September-October to limit TRY weakness, but it does not have a huge war chest like Brazil or Asia. Reserves were $84.4 bln at the end of October, down 10% from a peak of $93 bln in July. Reserves are thus less than short-term debt of around $85 bln, making a protracted intervention defense unworkable. Instead, the central bank should hike interest rates. While it wouldn’t save the lira in this environment, it would be a step towards re-establishing credibility and perhaps help it become an EM market performer instead of an underperformer.