The markets are already speculating on this: State intervention is falling into the hands of the new finance minister.
(Photo: Reuters)
istanbul The Turkish lira fell the most against the dollar on Wednesday, its biggest drop in more than a year. Traders reported that state-owned banks had stopped backstopping – buying lira and selling dollars.
On Wednesday morning, the lira posted its biggest one-day drop in two years. In contrast, the dollar and euro rose about 7 percent to record highs of 23.185 and 24.824 lira respectively.
State-owned banks backed the lira for months ahead of Turkey’s presidential election at the end of May that ended in Recep Tayyip Erdogan’s re-election, primarily to boost Turks’ purchasing power ahead of the vote. However, this strategy depleted the central bank’s reserves.
In mid-May, official central bank data showed that net reserves fell to $2.33 billion ahead of the election. This is the lowest level in more than 20 years.
Turkey’s state-owned banks have yet to comment on their intervention in the foreign exchange market. The lira has lost more than 12 percent against the dollar since Turkey’s second round of elections on May 28.
This means that the appointment of Mohammad Simsek as finance minister has temporarily fallen through. The former Merrill Lynch strategist, who served as Treasury secretary in 2009 and 2018, declared over the weekend that his country would return to “rational fundamentals” in terms of economic and financial policy.
“Treasurer won’t set monetary policy in summer”
This return to more orthodox economic policy with less government intervention should in theory support the lira. However, Commerzbank expert Ulrich Leuchtmann explained that investors are clearly still skeptical about the sustainability of Turkey’s economic turnaround: “The finance minister will not set monetary policy in the summer.”
Recalling 2018, Leuchtmann said the appointment “may be a necessary but by no means sufficient condition for an actual permanent U-turn in monetary policy”. At the time, it turned out, of course the change was only temporary. “In my view, market participants will not soon forget this painful experience,” Leuchtmann said.
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The lira fell against the dollar at its highest point since the start of the year. (Source: Refinitiv)
Markets are now awaiting the appointment of a new central bank governor. Because Turkey is in crisis and is battling high inflation, which topped 85% at times last year. One reason for this is that the central bank did not raise the key interest rate in accordance with economic theory, but lowered it at Erdogan’s request.
Given Erdogan’s economic and monetary policies, the Turkish lira has fallen about 20 percent against the dollar since the start of the year. In 2021 and 2022, there will be a decline of 44% and 30%, respectively. Weak national currencies make the imports on which resource-poor countries rely significantly more expensive.
Analysts at Goldman Sachs have warned that the lira’s slide could continue, with the bank’s experts recently raising their forecasts for the currency against the dollar, citing mounting pressure on the currency.
A Revision to Rational Economic Policy?
According to a June 3 report, the bank expects the lira to weaken to 28 lira per dollar within 12 months, instead of the 22 lira per dollar it initially forecast. Commerzbank currently even estimates 30 liras against the dollar by the end of 2024.
However, a weaker currency could help with another problem: the trade deficit. This was helped by supportive purchases by the central bank.
That should change by now. Because when the exchange rate weakens, households and businesses typically reduce their purchases abroad. This reduces the country’s imports. At the same time, exports are increasing as products become cheaper abroad. Overall, the trade deficit has shrunk, so there is less pressure on the national currency.
Therefore, the current lira weakness may be a necessary correction required by Simsek to return to rational economic policy.
Data from Bloomberg and Reuters.
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