Elections in Türkiye: Last call for the Turkish lira? Ankara’s economic and financial fate hangs by the thin thread of the vote: what can happen with Erdoğan’s victory or defeat?
The elections in Turkey are also eagerly awaited for the effect on the Turkish lira and, in general, on the fate of the economically battered nation and in the grip of investor distrust.
The national currency is set to take a hit, regardless of the outcome of Sunday’s election between President Recep Tayyip Erdoğan and opposition contender Kemal Kılıçdaroğlu.
How bad a turkish lira crash predicted could be - and how quickly it and other Turkish assets stabilize afterward - will depend on whether the outcome leads to policy changes that put the $900 billion economy on a path of more sustainable growth. This is the general view of the analysts.
At first glance, the markets appear calm, but, just below the surface, they are going haywire, as evidenced in a Bloomberg analysis: volatility and risk protection costs have soared, some trading desks have suspended transactions and even riskier hedge funds are staying out.
Turkey’s road to greater credibility appears to be an uphill climb. Erdoğan has stepped up unorthodox policies since 2018, including interest rate cuts to stimulate growth albeit with inflation rising to record highs (usually, higher rates fight rising prices). Foreign investors have halved their holdings in Turkish stocks over the past five years and own less than 1% of lira-denominated government bonds.
Even in the scenario favored by the market - victory for the opposition - the path back to the traditional economy is bound to be bumpy. What is going to happen in Türkiye with the elections? The scenarios for the Turkish lira.
The Turkish lira and Erdoğan’s defeat
A Kılıçdaroğlu victory and opposition control of parliament is seen as the most positive outcome for the market, albeit with new risks surrounding the reversal from unorthodox policies.
The opposition alliance has promised a return to an interest rate policy similar to that of other countries and the appointment of an "autonomous" central bank chief, highlighting the contrast with Erdoğan, who has ousted three governors since 2019 seeking low borrowing costs.
JPMorgan and HSBC analysts expect lira depreciation to around 24-25 to the dollar, from 19.5 today. David Austerweil, deputy portfolio manager for emerging markets at Van Eck Associates, said he would go long Turkey’s inflation-linked bonds once the lira crosses 30. Options traders see a 65% chance that the lira is 23 against the greenback within three months.
The lira could depreciate sharply as the election results were announced with the opposition winning, Austerweil said. However, “once rock bottom is hit, both local depositors and foreign investors will start converting dollars into lira”, as the new government is expected to “immediately launch a large round of rate hikes to attract foreign capital” .
Cristian Maggio, head of portfolio and ESG strategy at Toronto Dominion Bank, believes that a return to orthodoxy would be gradual, however, because the risk of a currency explosion, which would also suppress economic expansion, would be politically too costly.
Erdoğan’s confirmation will be the defeat for the lira and the economy?
A win by Erdoğan and his AKP is widely seen as bad for the market. While this outcome is mostly viewed as a continuation of unorthodox policies, the risk of further detachment of asset prices from economic reality increases.
Union Investment’s Dergachev expects a slight reaction in the currency and credit markets in this scenario. The key question will be whether the president will change his stance on monetary policy or not pursue the same path of low rates and rising inflation.
Many of Wall Street’s biggest banks predict that current policies will be reversed even if Erdoğan remains in power, because they are no longer sustainable.
Not everyone, however, believes in this change. “The low interest rates policy appears to be a cornerstone of President Erdoğan’s political agenda and is therefore unlikely to change if he remains in office”, said Ulrich Leuchtmann, head of currency strategy at Commerzbank.
Turkey poised with any outcome
Fund managers warn that it will be a very difficult task to rebuild the Turkish economy and regain credibility among foreign investors, regardless of which party wins the election.
Cautious investor sentiment comes as Erdoğan fights his toughest re-election campaign after two decades in power. Polls show that Kılıçdaroğlu and Erdoğan are engaged in a very close battle just days before the elections, with voters betting on the economy as the central issue.
Erdoğan’s unconventional economic policies, including a long-standing objection to interest rate hikes, have helped send inflation above 85% in October, while the lira is dropped nearly 60% over the past two years to an all-time low against the dollar.
Less than 1% of Turkey’s domestic public debt is owned by foreigners, down from about a quarter a decade ago. The banking system, including domestic banks and Turkish affiliates of foreign lenders, now owns nearly 80 percent of the stock of local sovereign debt up from less than 50 percent in 2013, finance ministry data show.
A similar trend has taken hold in the Turkish stock market, where international investors have grabbed $7.3 billion over the past decade, according to Goldman Sachs.
The central bank has burned reserves, economists say, while politicians have tried to prop up the lira. Net foreign assets, a measure of the size of Turkey’s foreign currency "war chest," are less than $10 billion.
Investors fear that even a large policy adjustment, while important in the long run, would be very painful in the short term. Many experts, for example, expect Turkey’s benchmark tinterest rate will have to be increased over time from 8.5% today to 40% to show that the country is making a credible effort to tame inflation.
An interest rate hike of that magnitude would trigger a major sell-off in Turkey’s domestic bond market, which would be a near-term disaster for foreign investment. This process will also harm domestic banks as they now own such a large share of local bonds.
Turkey’s fate appears to be grim indeed, for whoever becomes president.
Original article published on Money.it Italy 2023-05-11 12:31:30. Original title: Con o senza Erdoğan, la Turchia rischia la disfatta economica
