Many of the points in this commentary were discussed on CNBC on June 8 2023.
After months of running down its reserves ahead of the recent elections, even those borrowed from local banks, Turkish authorities, led by new Economic Mehmet Simsek seem to be letting the lira go, allowing it to weaken sharply to try to close some of the macro imbalances. While lira weakening was to be expected, in the latest painful iteration of Turkey’s latest boom-bust economic cycle, the lira may struggle to find a floor given the typical risk of over-correction and the scale of the real over-valuation that has developed.
Not only was Erdogan’s re-election economically costly, prompting another domestic credit boom, but market actors remain skeptical. Many had hoped, unrealistically, for a change in government and associated change in macro policy including hikes to interest rates and other efforts to bring Turkey’s external deficit into balance. The challenge is that having allowed credit to boom, the adjustment is likely to be more painful. Simsek said today that he and his team aimed towards bringing predictability to Turkish macro policy. Other aspects of predictability including the room for the central bank to maneuver, investment and economic incentives will also be important.
Turkey has been very effective at finding new sources of cash over the last few years – including many billions of dollars of funding from the GCC, most recently 5 billion of Saudi money as recently as March. Erdogan and Simsek no doubt will be looking to add to these funds as well as secure other swap lines and financing for reconstruction.
The recent softening of energy and food prices has helped Turkey, especially as it has been among countries benefiting from Russian discounts and delayed payment terms, but ultimately these trends have not been enough given the sheer flow of capital out of Turkey as the past macro leaders spent reserves to prop up an unsustainable currency.
Ultimately, other macro policies including investment and trade, as well as creative ways to shore up the banks will likely be needed. Turkey has a real need of funds for reconstruction and associated projects.
GCC supporters of Turkey are likely to continue to invest, but were unwilling to continue to provide funds to keep the currency unsustainably strong. As with Egypt, they likely expected the Turks to allow the currency to adjust rather than sending more good money after bad.
Turkey is ultimately likely to strike deals with some GCC investors, and other regional players, and seek to balance its regional and global interests, including continuing to access preferential energy deals and loans from Russia, while trying to avoid notable financial sanctions. This balancing act will continue to be difficult from the macro basis.
A sharp drop in the currency like Turkey’s is likely to lead to some adjustment of the external balance, most likely because of a sharp fall in imports. Turkey will continue to struggle to take advantage of its cheaper currency to support exports, given that most of those exports still require imports.
The sharp depreciation in Turkey is unlikely to prompt meaningful contagion in other large EM countries, given that few other sizeable EM have the sort of imbalance that Turkey does. While several Frontier markets have lost market access and struggle to get external finance, most large EM, in EMEA, or Latam, have more manageable external debt burdens – and some like Brazil have seen significant positive real rates and widening current account surpluses. The painful Turkish adjustment, which likely will be done without IMF help, requires a difficult balancing act, economically and politically.
Ziemba Insights 