Lira plunges 7% as Turkey edges towards free market

Reuters/Dado Ruvic

• Currency in worst selloff since historic 2021 crash
• After election, state’s FX-stabilising measures loosen
• Expectations grow for possible emergency rate hike

Turkey’s lira plunged 7.6 percent to a record low on Wednesday in its biggest selloff since the historic 2021 crash, and traders called it a “strong signal” that Ankara is moving away from state controls toward a freely traded currency.

The lira has come under increasing pressure since President Tayyip Erdoğan was re-elected on May 28. It was trading at 23.23 against the dollar at 17.39 GMT, after touching a record low of 23.26, bringing losses this year to nearly 20 percent.

Under Erdoğan’s unorthodox programme, authorities have taken a hands-on role in foreign exchange markets, using up tens of billions of dollars of reserves this year alone to hold the lira steady.

The central bank’s net forex reserves hit an all-time low of negative $4.4 billion last month as demand surged through the elections.

But Erdoğan signalled a U-turn at the weekend when he named Mehmet Şimşek, a former deputy prime minister who is well regarded by foreign investors, as finance minister. Şimşek later said economic policy needed to return to “rational” ground and on Wednesday said there were “no quick fixes” for policy.

Four traders said the decline in the central bank’s forex and gold reserves had stopped as of last week and could begin to recover, along with signs of the change in forex policies.

Though many regulations need to be changed, “the destination is becoming clearer every day: We are going towards the lira’s value being determined by market conditions”, one trader said.

Erdoğan is considering appointing Hafize Gaye Erkan, a US-based senior finance executive, as central bank governor, Reuters reported on Monday. She would succeed Şahap Kavcıoğlu, who has spearheaded Erdoğan’s rate-slashing drive since 2021.

Given the heavy selloff, some analysts said the central bank might hold an emergency meeting to hike interest rates.

An emergency hike “is very possible and could stabilise markets in the short-term”, said Ulricht Leuchtmann, head of FX research at Commerzbank.

“It smells like the beginning of a lira crisis,” he added. “This is what happens when you get an exponential move – for a long time you think nothing happens, and then all of a sudden all hell breaks lose.”

The bank’s next policy meeting is scheduled for June 22.

Some analysts expect the lira to weaken towards a range of 25-28 against the dollar.

Another trader said the currency was nearing levels at which it “will not need to be defended with reserves”, adding that sharp intraday losses could continue for some time.

Return to orthodoxy

Under pressure from Erdoğan, a self-described “enemy” of interest rates, the central bank slashed its policy rate from 19 percent to 8.5 percent in 2021 to boost growth and investment.

But it sparked a historic lira crisis in December of that year and sent inflation to a 24-year high above 85 percent last year.

The return of Şimşek, who was finance minister and deputy prime minister in 2009-2018, signalled a move away from the unorthodox rate cuts despite high inflation that have sparked a more than 80 percent erosion in the lira’s value in five years.

Erkan, the candidate to run the central bank, met with Şimşek in Ankara on Monday and was set to later meet Erdoğan, Reuters reported.

A former co-CEO at First Republic Bank, Erkan would be the country’s fifth central bank chief in four years, after Erdoğan fired previous governors as part of frequent policy pivots.

Turkish authorities are now hoping foreign investors will return after a years-long exodus, but market watchers cautioned that Erdoğan turned to conventional policies in the past only to change his mind shortly after.

Turkey’s sovereign dollar-denominated bonds gave away early gains to trade slightly negative on the day.

The premium demanded by investors to hold the country’s hard-currency bonds over safe-haven US Treasuries widened again to 472 bps after tightening nearly 200 bps in the second half of May, data from JPMorgan showed.

Five-year credit default swaps dipped to 485 from Tuesday’s close of 491.

The main BIST-100 stock index has rallied in nine of the last 10 trading days, and closed 3.2 percent higher on Wednesday. The banking index rose some 2.39 percent.

“The process of getting Turkey onto a sustainable path is going to be turbulent and likely involves substantial devaluation and higher yields,” said Paul McNamara, director of emerging market debt at asset manager GAM.

“We think fair value for the lira is probably 15 percent or so lower, but containing a devaluation without substantial external support is going to be a desperately difficult task,” he said before Wednesday’s decline.