Turkey has never been so cheap

The Turkish lira has had a lousy 2016 and the currency has immediately taken another hit in the new year. Chances are, however, that a revival will not be long in coming.

The Turkish lira lost much of its value in 2016 due to the failed 'coup' of July 15. The exchange rate of the Turkish lira has been one low after another. So much so that at the beginning of December Turkish President Recep Tayyip Erdogan called on his compatriots to exchange their foreign currencies for Turkish lira in order to boost the rate of the Turkish currency.

Unfortunately without result. The free fall of the Turkish lira will continue with force in the new year. In the first days of the new year, the currency plunged almost 2 percent in the aftermath of the terrorist attack in nightclub Reina on New Year's Eve and the publication of disappointing economic data. A lira is now worth 0,265 dollars or 0,25 euros. That is 20 percent and 18 percent less than a year ago. This makes the Turkish lira one of the most volatile currencies in the world. 

It is not difficult to point out reasons for the free fall of the Turkish currency. Political uncertainty has risen sharply after the failed coup d'état on 15 July last year. President Tayyip Erdogan has taken all kinds of measures to tighten his grip on power and to arrest or otherwise sideline anyone who may be involved in the coup. These measures have an impact on the economy. In the third quarter of 2016, Turkish consumers spent 3,2 percent less than in the same period a year earlier. The economy shrank by 1,8 percent, after growing 4,5 percent in the first half.

Shrinking economy and rising inflation

Turkey is not only dealing with an economy that is shrinking, but also with stubbornly high inflation. Last week it was announced that inflation rose to 8,53 percent in December. That percentage is far above the official target of the 5 percent that the Turkish central bank uses. Inflation is also above the official interest rate of 8 percent. Because inflation is higher than the interest rate, the so-called real interest rate in Turkey is negative. This makes it unattractive for parties to hold their assets in lira. 

Sellers from the market

It is precisely the enormous pessimism about the lira that could lead to the currency rebounding soon. If everyone has already chosen a position for a further decline, there are few potential sellers left in the market. Due to the strong negative sentiment, any news that is slightly less bad than feared could trigger a small rally of relief. In the early days of the year, four of the five currencies that fell the hardest in the last quarter of 2016 have suddenly skyrocketed: the Japanese yen, the Korean won, the Polish zloty and the Norwegian krone. The Turkish lira is the only one of the five that has fallen further. 

The next meeting of the Turkish central bank is scheduled for Tuesday, January 24. The expectation is growing that the Turkish central bank will intervene in the short term. Even if they leave interest rates unchanged, the outlook for the lira could improve in the coming weeks. There is a good chance that the inflation jump is due to an increase in the tax on alcohol and tobacco. If inflation falls back below the official interest rate in January and the real interest rate becomes positive again, the threshold for holding assets in lira falls. For the time being, I would therefore rather bet on a recovery of the Turkish currency after the hard blows of recent times than on a further decline.

Lawrence Martins

Laurens Maartens is a currency expert at the Dutch Payment and Exchange Company (NBWM). Maartens analyzes current currency developments and also provides lectures and training in the field of currency management.

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