Select your investor profile:
This content is only for the selected type of investor.
Individual investor?
Emerging Markets
Turkish currency crisis
Turkey's ugly choices
August 2018
Turkey's government has backed itself into a position where it faces unenviable policy alternatives. Investors are watching closely.
As the currency crisis roils the Turkish economy, its government is faced with three options. It can raise interest rates sharply to defend the beleaguered lira. It can pull down the shutters and try to keep capital from fleeing the economy. Or it can print money.
Which of these alternative policy measures Turkish President Recep Tayyip Erdogan chooses will determine how well investors fare.
The best and most positive for markets would be for the Turkish central bank to raise interest rates sharply. At the heart of the currency crisis are the country’s deeply negative real interest rates. Two year local currency government bonds yield around 25 per cent, which is a best approximation of what the market thinks will happen to inflation– the year-on-year rate to July, latest reading available, showed a rate of 16 per cent, but a hefty devaluation in the lira since means it will climb sharply. Turkey’s dependence on commodity imports means that the fast falling lira is causing the country’s inflation rate to accelerate. If the market’s right about the course of inflation, real rates will be deeply negative if official interest rates remain at 17.75 per cent.
In order to put a brake on this price spiral, rates would need to be hiked – and soon. As long as investors believe the central bank is committed to controlling inflation, this would stabilise the currency – albeit at the cost of what would almost certainly be a sharp recession. But with price pressures under control, the central bank would then be able to start cutting rates again, which historically has been a strong buy signal for emerging market investors. Typically, inflows of foreign capital nurture a virtuous circle of appreciating currency and falling inflation.
Ouch
Turkish lira/dollar exchange rate
Source: Thomson Reuters Datastream. Data from 30.12.2017 to 17.08.18
Unfortunately, Erdogan has been adamantly against raising interest rates. Indeed, he’s argued that interest rate hikes are what cause inflation. And his moves to end the Turkish central bank’s independence means that it won’t buck political pressure.
In the absence of a market-friendly solution, Erdogan can raise capital controls – restricting how much foreign currency can be taken out of the country. Controls can work for countries without a lot of foreign debt, like China. But for those like Turkey that have very high levels of external debt, which needs to be serviced and rolled over, capital controls cause serious economic damage.
There are already signs of soft barriers. Anecdotally, people who have tried to do large currency transfers abroad have been told by their banks that only limited amounts would be transferred. Erdogan has already been calling for Turks to “show their resistance to the world” by converting their gold, euro and dollar holdings into lira.
Capital controls would lock up investors’ cash in Turkey, a distinctly unattractive outcome.
Erdogan’s final option would be to have the central bank print money to keep sufficient liquidity at domestic banks. The alternative would be crippling bank runs. But printing money under these circumstances would lead directly to further currency depreciation, further inflation and, ultimately, be highly damaging to the economy. Venezuela offers a clear example of how badly this policy can go.
Turkey’s economic fate hangs on which option Erdogan’s government chooses. Investors will be watching closely.
Related articles
Emerging Markets
A tale of two emerging market crises
Anjeza Kadilli, Economist, Nikolay Markov, Senior Economist
August 2018
Emerging Markets
Turkey: a canary in the emerging market coalmine?
Alain-Nsiona Defise, Head of Emerging Corporates, Mary-Therese Barton, Head of Emerging Market Debt
August 2018
Important legal information
This marketing document is issued by Pictet Asset Management. It is neither directed to, nor intended for distribution or use by any person or entity who is a citizen or resident of, or domiciled or located in, any locality, state, country or jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. Only the latest version of the fund’s prospectus, the KIID (Key Investor Information Document), regulations, annual and semi-annual reports may be relied upon as the basis for investment decisions. These documents are available on assetmanagement.pictet.
This document is used for informational purposes only and does not constitute, on Pictet Asset Management part, an offer to buy or sell solicitation or investment advice. It has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of an opinion, based on available data at a specific date. The effective evolution of the economic variables and values of the financial markets could be significantly different from the indications communicated in this document.
Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to change without notice. Pictet Asset Management has not taken any steps to ensure that the securities referred to in this document are suitable for any particular investor and this document is not to be relied upon in substitution for the exercise of independent judgment. Tax treatment depends on the individual circumstances of each investor and may be subject to change in the future. Before making any investment decision, investors are recommended to ascertain if this investment is suitable for them in light of their financial knowledge and experience, investment goals and financial situation, or to obtain specific advice from an industry professional.
The value and income of any of the securities or financial instruments mentioned in this document may fall as well as rise and, as a consequence, investors may receive back less than originally invested. Risk factors are listed in the fund’s prospectus and are not intended to be reproduced in full in this document.
Past performance is not a guarantee or a reliable indicator of future performance. Performance data does not include the commissions and fees charged at the time of subscribing for or redeeming shares. This marketing material is not intended to be a substitute for the fund’s full documentation or for any information which investors should obtain from their financial intermediaries acting in relation to their investment in the fund or funds mentioned in this document.
EU countries: the relevant entity is Pictet Asset Management (Europe) S.A., 15, avenue J. F. Kennedy, L-1855 Luxembourg
Switzerland: the relevant entity is Pictet Asset Management SA , 60 Route des Acacias – 1211 Geneva 73
Hong Kong: this material has not been reviewed by the Securities and Futures Commission or any other regulatory authority. The issuer of this material is Pictet Asset Management (Hong Kong) Limited.
Singapore: this material is issued by Pictet Asset Management (Singapore) Pte Ltd. This material is intended only for institutional and accredited investors and it has not been reviewed by the Monetary Authority of Singapore.
For Australian investors, Pictet Asset Management Limited (ARBN 121 228 957) is exempt from the requirement to hold an Australian financial services license, under the Corporations Act 2001.
For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.
For US investors, Shares sold in the United States or to US Persons will only be sold in private placements to accredited investors pursuant to exemptions from SEC registration under the Section 4(2) and Regulation D private placement exemptions under the 1933 Act and qualified clients as defined under the 1940 Act. The Shares of the Pictet funds have not been registered under the 1933 Act and may not, except in transactions which do not violate United States securities laws, be directly or indirectly offered or sold in the United States or to any US Person. The Management Fund Companies of the Pictet Group will not be registered under the 1940 Act.
Pictet Asset Management Inc. (Pictet AM Inc) is responsible for effecting solicitation in North America to promote the portfolio management services of Pictet Asset Management Limited (Pictet AM Ltd) and Pictet Asset Management SA (Pictet AM SA).
In Canada Pictet AM Inc. is registered as Portfolio Manager authorised to conduct marketing activities on behalf of Pictet AM Ltd and Pictet AM SA. In the USA, Pictet AM Inc. is registered as an SEC Investment Adviser and its activities are conducted in full compliance with the SEC rules applicable to the marketing of affiliate entities as prescribed in the Adviser Act of 1940 ref. 17CFR275.206(4)-3.