Disastrous year for the lira, peak year for Turkish equities

Skyrocketing inflation in Turkey has both predictable and unpredictable consequences. For example, it is not surprising that the economy is struggling and the lira is under pressure. But it comes as a big surprise that high inflation is also triggering a rally in the Turkish stock market.

Investors will probably be surprised when they see the lists of winners and losers in 2022. In a pretty bad investment year, the Istanbul stock market stands out with a return of 173%. However, this rally is not caused by the fact that the financial world is suddenly very interested in Turkish business. The country's economy is going through a very difficult period, with inflation even exceeding 80% in recent months. In almost every country, high inflation prompts the central bank to raise interest rates. This slows down the economy, causing inflation to fall. Turkey, however, is a notable exception to that rule.

Against the flow
Under pressure from President Recep Tayyip Erdoğan, the Turkish Central Bank (TCMB) has chosen to cut interest rates. Against his better judgement, he hopes that this will fuel economic growth high enough that the country will grow out of the problems. While central banks in Europe and the United States are raising key rates this week, the TCMB has cut its key rate since June from 14% to 9%. The combination of falling interest rates and sky-high inflation makes the lira very unattractive on currency markets. The currency has fallen by 2021% against the euro since the end of 24. This makes it increasingly expensive for the population to buy foreign goods and services.

When investing seems safer than saving
The free fall of the lira is also the reason why the Turkish stock market is skyrocketing this year. Because the value of a savings balance is eroded very quickly, many households choose to hold their assets in shares. For the time being this is working out well, but only the inflow of household wealth is a very shaky basis for the stock market rally. Especially since the Turkish economy is probably still in for a major shock. Presidential elections will be held on June 18. And it seems that Erdoğan is willing to pull out all the stops to get re-elected. Rumors are circulating that he wants to raise the minimum wage significantly to improve his re-election chances.

False stability
With that, Erdoğan runs the risk of jeopardizing business support and good stock market sentiment. The central bank has unfolded dozens of new rules in recent months and set aside additional foreign currency reserves. This serves as ammunition with which the TCMB can stabilize the value of the lira in the run-up to the elections. If that succeeds at all, it is at most a temporary false stability. Without a politically independent central bank convincingly tackling inflation, it is inevitable that the lira will eventually resume its slide. For example, after a price drop of almost 90% in the past decade, things do not look good for the Turkish currency in 2023 either.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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