Meanwhile, In Turkey…

“Turkish Lira Buoyed by Conservative Half-Point Cut”, reads a Bloomberg headline which accidentally qualifies as one of the better punchlines you’ll read this week.

It’s not that it isn’t accurate. It’s just that “conservative” is an extremely relative term when it comes to Turkey and rate cuts.

For the uninitiated, allow me to illustrate. There is nothing “conservative” about the following visual, which shows you the nine cuts Murat Uysal has implemented over his 10 months as CBT governor.

Uysal of course replaced Murat Cetinkaya last summer, after Cetinkaya failed to slash rates fast enough to appease a perpetually impatient Recep Tayyip Erdogan, whose “unorthodox” (and that’s a laughable euphemism) economic views generally hold that lower rates lead to lower inflation and, by extension, currency stability.

After Thursday’s cut, Uysal has delivered a total of 1,575bps worth of easing. It’s true that inflation has moderated in Turkey and central banks around the world are obviously slashing rates at a furious pace to help offset the economic hit from the virus. But, as ever, it is not generally advisable to push real rates deeply negative if you rely on external financing.

As noted earlier this month, Turkey needs to roll something like $170 billion in foreign currency debt over the next 12 months. Between jittery markets and Erdogan’s legendary belligerence, Ankara is taking a big risk at a delicate juncture.

Turkish banks have been blowing through billions to defend the currency, and Erdogan eventually resorted to a familiar tactic – namely positing a foreign conspiracy against “his” lira.

On May 7, he banned local lenders from engaging in lira transactions with Citi, UBS and BNP, after state media blamed “London-based institutions” for orchestrating a “manipulative attack” on the currency. Three days later, he reversed the ban.

If you read some of the commentary from analysts and veterans here, you’d come away thinking Erdogan thought better of the crackdown. I doubt it. That aggressive maneuver was the culmination of the latest round of measures aimed at curbing pressure on the currency, and these come in waves. He usually pushes the envelope as far as he can, before walking things back without apologizing. It’s not really a “relent”, and it damn isn’t an admission of a flawed strategy. Rather, it’s exactly what it looks like: An autocrat testing boundaries.

Erdogan on Monday declared victory and then threatened would-be saboteurs. “We have foiled the attack on our country through foreign currencies”, he said, in a series of silly remarks following a cabinet meeting. “We will never show mercy to those smuggling foreign currencies to outside the country”.

One thing I repeatedly emphasize when discussing anything to do with Turkey is that Erdogan has an uncanny knack for extricating himself from political and economic peril. That’s underscored by the following short excerpt from SocGen’s Phoenix Kalen, writing earlier this week on the lira “defying the odds”:

Despite low levels of international reserves and deeply negative policy rates, TRY has been defying the odds in recent days, outperforming its high-yielding EM FX counterparts. This marked resilience may be attributable to continued currency interventions via state banks, regulatory interventions that magnified the risk of speculative short TRY positions (e.g. recent ban barring Citi / BNP / UBS from trading in TRY currency markets; subsequent ban reversal), and speculation that Turkey may be close to securing USD 20bn in currency swap lines with Japan and the United Kingdom (swap agreements of USD 10bn each). In particular, the environment of heightened regulatory uncertainty has sharply curtailed foreign investor activity in Turkish assets, perpetuating a multi-year trend — foreign holdings of TURKGBs have declined further to a low of 5.0% this month.

Turkey was angling to get access to the Fed’s swap lines, which were extended in March to include New Zealand, Australia, Brazil, South Korea, Denmark, Norway, Singapore, Sweden and Mexico, in addition to the standing arrangements with the BOC, the BOE, the BOJ, the ECB and the SNB.

Asked on May 6 about the prospect of extending a life raft to Turkey, Richmond Fed chief Thomas Barkin seemed to shut the door. The Fed’s swap lines are for countries which have “a relationship of mutual trust” with the US, he said. “It does not cover all the countries”.

Japan and the UK are seen as potentially open to an agreement, but officials from both countries downplayed such rumors this week.

Any yet, Erdogan is savvy. You may recall that in September of 2018, after Turkey barely dodged a total debacle that could have forced the country into the arms of the IMF, Erdogan secured financial assistance from his allies in Qatar, who rode to the rescue with a swap arrangement at a time when CDS spreads on Turkey had exploded higher.

Earlier this week, Qatar tripled that swap line to $15 billion.

Officially, the decision is aimed at bolstering “bilateral trade in respective local currencies and support[ing] the financial stability of the two countries”. But really, it’s about further cementing a mutually-beneficial alliance that dates back to the failed coup against Erdogan in 2016.

The following year, Turkey supported Qatar when a Saudi-led alliance sought to isolate Doha both economically and diplomatically on the rather hypocritical excuse that Qatar sponsors terrorism. That was perhaps the most glaring example of the pot calling the kettle a Sunni extremist in the history of Mideast politics, but it served a purpose – namely to send a message about the consequences for Doha of pursuing an independent foreign policy when it comes to Iran.

“Some say Turkey is becoming a burden on Qatar”, one expert on Turkey’s Gulf relations told FT this week. “But from the Qatari perspective, no matter how much [an agreement with] Turkey might cost, it will always be cheaper politically and economically than remaining alone in the region. Without Turkey, Qatar would be in a really critical situation”.

Right. And that’s underappreciated by market participants – but it’s not underappreciated in Doha, that’s for sure.

“The higher limit on the swap deal could effectively raise Turkey’s reserves by up to $10 billion, adding to a stockpile whose size was called into question by investors because the central bank boosted them by including dollars borrowed from commercial lenders in its foreign holdings”, Bloomberg noted, in a short piece this week.

And it’s not just Qatar that Turkey has leaned on over the past couple of years. In September of 2019, markets learned that Beijing helped prop up the country’s foreign reserves in and around the crucial re-run of the Istanbul election. Specifically, the PBoC sent $1 billion to Turkey a year ago under a 2012 lira-yuan swap agreement.

Between Qatar topping up its assistance and the distinct possibility that the disinflationary impulse from the pandemic will open up more room for rate cuts, it’s conceivable that Erdogan will escape the jaws of a currency crisis again, despite cutting rates, on average, almost once a month for nearly a year. After hitting a record low, the lira is starting to recover, and Turkey’s daily COVID-19 case rate is falling.

“Notwithstanding recent currency volatility, the disinflationary dynamics resulting from the impact of the COVID-19 pandemic and associated lockdown measures are gradually pulling inflation expectations lower”, SocGen’s Kalen wrote on Tuesday. “12-month-ahead inflation expectations have declined to 9.2% in May from 9.7% the previous month, while 24-month-ahead inflation expectations have declined to 8.3% from 8.6%”.

Note that if you assume inflation falls even to 100bps above CBT’s year-end expectation (so, let’s say it falls to 8.4% as opposed to the 7.4% the central bank is now projecting), it would mean real rates are currently around zero. Not great, but not as bad as -2.7%, and assuming the currency remains some semblance of stable, CBT will probably keep easing.

To be clear, Turkey is far from out of the woods. In addition to all of the obvious concerns mentioned and alluded to above, a good Bloomberg piece out Tuesday details yet another avenue through which Erdogan’s insistence on growth at any cost could accelerate dollarization to the detriment of currency stability.

And yet, the overarching point is that Erdogan is almost impossible to box in. Turkey’s descent into one-man rule over the past several years is regrettable indeed, and one day, the chickens will come home to roost for NATO’s favorite autocrat. But that day isn’t nigh, apparently.


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