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Hagia Sophia issue and provocations against Greece precipitated sharp fall of Turkish lira, analysts say

Jul 29, 2020 | 17:39
in Society
Hagia Sophia issue and provocations against Greece precipitated sharp fall of Turkish lira, analysts say

According to Capital Economics, Turkey’s economy is collapsing and the country is facing the risk of a new monetary crisis, not only because of the shock of the pandemic but mainly because of the deterioration of its relations with the EU.

Capital Economics also estimates that the Turkish lira could significantly overshoot its fair value (a depreciation to 8-9/$).

According to Capital Economics, the most immediate threat to the Turkish lira, which is already on the verge of collapse, stems from concerns about Turkey’s relations with the EU. The decision to convert Hagia Sophia into a mosque sparked rumours that the EU may cancel its customs union with Turkey, while French President Emmanuel Macron argued last week that the EU should impose sanctions on Turkey due to drilling operations in Greek and Cypriot waters.

Referring to yesterday’s strong depreciation of the Turkish lira (considering that it was depreciated by 8% last month), Capital Economics highlights that it marks the first significant departure from the de facto peg of 6.85/$, which had been in place last month. If tensions with the EU continue to escalate, greater and more sharp depreciation of Turkey’s currency is expected. This could eventually force the central bank to raise interest rates.
The coronavirus pandemic provoked a decline in exports and the tourism sector has “frozen” causing a sharp rise in the current-account deficit in recent months, as reported by Capital Economics. And Turkey’s large short-term external debts ($ 170 billion, 22% of GDP) leave the economy exposed to a tightening of external financing conditions.

Financial support from Qatar pulled Turkey back from the brink of another currency crisis in May and policymakers have also tried to ease pressure on the lira through import compression – a raft of tariff hikes have been imposed in recent months – as well as soft capital controls.

But support from Qatar was never more than… a sticking plaster. While the tripling of the currency swap line has boosted Turkey’s net FX reserves, these still stand at just $32.5bn. Policymakers have made heavy use of FX swaps with local banks – as of May, these stood at $54.4bn, up from $19.0bn at the start of 2020.

According to Capital Economics, the most immediate threat to the Turkish lira stems from concerns over Turkey’s relations with the EU due to the conversion of Hagia Sophia into a mosque and to tensions in Greek and Cypriot waters. Past experience shows that, even if sanctions were limited in scope, the threat of more action and the damning signal it would send about Turkey-EU relations would cause capital inflows to dry up and put further downward pressure on the lira. This would put the spotlight back on the central bank and provide an acid test of its willingness to shrug off pressure for President Erdogan and hike interest rates.

“We hold serious doubts that the central bank would act in a timely manner, running the risk of another currency crisis. The experience from 2018 is that the currency could significantly overshoot its fair value and depreciation to 8-9/$ would certainly not be out of the question,” Capital Economics concludes.

Tags: society

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