Turkey’s courting of carry traders risks leaving it exposed

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• Carry traders drawn to Turkey
• Lending rate above 50%
• Currency flows could reverse

While fund managers are still moving into the Turkish carry trade market, there are rising concerns these flows could reverse, leaving the economy exposed. 

In this instance, carry trading involves borrowing currency in low-yield foreign economies to convert into the lira to reap rewards from Turkey’s high interest rate environment.

Turkey became very attractive to carry traders after the central bank raised its key lending rate to 50 percent in late March, with commercial banks’ rates even higher. 

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The sharp rise in the bank’s rate was made to target rising inflation, which peaked at 75.5 percent in May, before falling back to 61.8 percent as of the end of July.

Since April 1, just after the central bank’s last rate hike, Turkey has attracted more than $20 billion in carry trade funds, according to banking data. This is despite a brief outflow after the uncertainty over the resilience of the US economy saw markets fall on August 5, or “Black Monday”, as it was dubbed in Turkey. 

While the carry trade inflows remain strong, foreign direct investment has eased across the first half of 2024. FDI was down 5 percent year on year, according to data issued by the International Investors’ Association of Turkey (YASED) on August 13. 

Turkey’s FDI inflows slowed to $800 million in June, well down on the $1.3 billion in April, the YASED data showed. The six-month total of $4.7 billion was less than half the year-end $10.6 billion posted in 2023. 

By encouraging the carry trade, Turkey is putting hopes of sustained growth in the real economy at risk, said Erinç Yelden, professor of economics at Istanbul’s Kadir Has University. 

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“Hot money that comes in quickly may also leave as fast,” he told AGBI. “As well as having high risk, it also creates a high import addiction, it sets back exports. It harms local producers’ capability to compete and structurally creates unemployment.”

However, with the central bank having built up its foreign currency reserves from a negative position of $65.5 billion at the end of March to more than $93 billion by late July, it was able to inject $6.2 billion to support the lira on Black Monday to protect the currency and reverse the carry trade outflows, said economic journalist Erdal Sağlam.

“The sales in the carry trade returned to buying by Friday,” he said. “The central bank has the base to intervene now so I don’t see a problem in the carry trade situation for now.”

With the potential for interest rate cuts in November or December, if inflation continues to fall, Sağlam said there could be a move into bonds, rather than the rapid yield, but riskier, carry trade late this year.