Is the Turkish lira hopelessly lost?

The depreciation of the Turkish currency (the lira) gained momentum in week 32. If the central bank does not act quickly and decisively, the consequences will soon be unimaginable.

The Turkish lira has fallen hard. Monday, August 6, the currency fell by more than 5% (temporarily), when the United States (US) announced that the duty-free import of items from the country is being scrutinized. This creates the danger that Turkish companies will soon have to pay import tax on almost €1,5 billion worth of goods.

The news comes on the heels of an announcement that Turkey is introducing a tariff on certain US goods, in response to the US steel import tax introduced earlier this year. Tensions between the two countries had already risen over Turkey's refusal to release American pastor Andrew Brunson.

Structural problem
After the recent price drop, 1 lira is worth only €0,16. At the end of last year that was more than €0,22 and in the autumn of 2010 you even got more than €0,50 for 1 lira. The trade dispute with the US has accelerated this slide. Even if Turkey manages to settle the trade conflict, the end of the free fall is not yet in sight. To do this, a more structural problem must first be tackled.

The value of the lira becomes for years eroded by high inflation. In recent months, inflation has risen from just over 10% to 16%. This increase is partly due to the depreciation in value. As the Turkish government waits to intervene, it becomes increasingly difficult to break the vicious circle (of a falling lira and rising inflation).

However, recently re-elected Prime Minister Recep Tayyip Erdogan opposes the rate hikes by which central banks are trying to keep inflation under control. In his view, rising interest rates put too much of a brake on economic growth.

Surprise
In response to the fall in the lira, the central bank has relaxed reserve requirements for banks somewhat. That is, however, a drop in the ocean. Due to all the uncertainty, the yield on 10-year Turkish government bonds has already risen to almost 20%. In June, interest rates were already raised by 125 basis points.

The next meeting is not until Thursday 13 September, but the bank already proved earlier this year that it is prepared to intervene unexpectedly if the circumstances require it. If such a surprise move is not forthcoming, a lira may soon be worth only a dime.

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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