For the second month in a row, the Turkish central bank (CBRT) surprised the market. After hiking rates against expectations in September, the bank appeared to be returning to more orthodox policy. However, last Thursday the authorities kept the weekly repo rate on hold at 10.25%, against consensus expectations for a 175 basis points (bps) increase in the CBRT’s policy rate to 12%. As such Turkish assets traded poorly, with the lira selling off by as much 2.5% and hitting record lows.
It has been clear for some time that monetary policy in President Recep Tayyip Erdogan’s Turkey is as much a political decision as an economic one. But underneath the surface the authorities did move to tighten liquidity by increasing the rate on the late liquidity window (LLW) by 150 bps to 14.75%. The LLW is supposed to be used only in times of stress but over the last few years has taken on an increasingly larger role in the CBRT’s operations. This is part of wider liquidity tightening measures aimed at increasing the effective funding rate – and in this respect they have been relatively successful, with the effective funding rate up 5.5% since July this year, while the official policy rate has only increased 2% during this period.
We think that the adjustment to the LLW will lead to a further tightening in the effective funding rate from its current 12.75%. Based on the current ratio of liquidity operations being offered, we believe that the effective funding rate will increase in the coming weeks, initially to 13.5%, but possibly higher as well. The question is whether this will be sufficient to stabilise the lira and reverse the trends in deposit dollarisation. By leaving its main policy tool unchanged it sends a less hawkish – and somewhat confused – signal when compared to last month’s policy rate hike.
Ultimately, we think the real policy rate has to move materially higher to act as an anchor on the lira and avoid a vicious cycle of lira depreciation driving further inflation. Real rates are creeping higher, for instance the 12-month lira deposit rates are up to 12.8%, versus current official inflation of 11.75% and 12-month forward inflation expectations of 10.5%. However, compared to historical episodes, real rates do not appear anywhere near high enough to stabilise the situation. Without high real interest rates to support the lira, the CBRT has fallen back on its currency reserves to prevent further depreciation amidst an increasingly concerning geopolitical outlook. Repeated FX intervention – and a widening current account deficit – has push the CBRT’s foreign currency reserves to multi-year lows. Yet despite the interventions, the currency has hit record lows and has been amongst the worst performing currencies globally. Thus, we think that material hikes to the main policy rate are a necessary requirement to stabilise the currency and encourage depositors back into lira accounts. But Thursday’s decision suggests authorities are unlikely to act swiftly and raises the possibility of further currency volatility as well as a hard landing (whereby a sharp FX move forces the CBRT into a rapid and severe rate hike).
Looking across the spectrum of Turkish assets, we still believe there is a strong degree of fundamental resilience in the corporate space, especially in select financial issuers and in technology, media and telecom. Here we remain confident in their ability to weather the challenging monetary backdrop, and they remain particularly attractive from a valuation perspective.
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