Has the lira meltdown begun?

After hitting 3 for the first time ever in the early hours of Aug. 20, the Turkish Lira-dollar exchange rate recovered somewhat during the day. Several readers have asked me if the lira’s slide would continue. Well… yes and no.

In the short run, a definite, yes. For one thing, global developments continue to strengthen the dollar and weaken emerging market (EM) currencies. While every new data release seems to point to a strengthening American economy, and therefore raise the likelihood of an imminent rate hike by the U.S. central bank Federal Reserve (Fed), the risk of a Chinese economic crisis and lower commodity prices are rattling EMs.

As a result, capital’s exodus from EMs continues. Nearly 1 trillion dollars has left them during the last 13 months, and according to Bank of America Merrill Lynch, funds are holding their lowest EM exposure since 2001. Usually labeled by economists as one of the most fragile EMs, it is no wonder that Turkey is leading the pack. Although there were minor inflows this week, there have been outflows from Turkish bonds and equities for most of the year.



Domestic developments are not helping, either. The country is headed towards a reelection with a lame duck government made up of members of different political parties. There are attacks by the outlawed Kurdistan Workers’ Party (PKK) almost every day and the Islamic State of Iraq and the Levant (ISIL) recently put Turkey on its enemy list.

Despite these developments, the Central Bank stayed on hold at its monthly interest rate-setting meeting on Aug. 18. At the Bank’s meeting with economists the next day, Deputy Governor Turalay Kenç shocked me by underlining that volatility in global financial markets would abate once the Fed started rate hikes. All in all, the bank is looking rather complacent - and willing to tolerate lira depreciation.

Unfortunately, this is exactly how all policymakers are feeling. President Recep Tayyip Erdoğan’s economy adviser, Cemil Ertem, reiterated Economy Minister Nihat Zeybekçi’s recent remarks that there was no reason to worry, adding that 3 would be a competitive lira-dollar exchange rate. You don’t shout “fire” in a crowded movie theater, but according to Nomura’s Tim Ash, thanks to Ertem, investors targeted, and eventually reached, this level.

And it is not only foreign investors. You would expect domestic residents to see the current exchange rate as an opportunity to sell the greenback, but instead they are hoarding more dollars, which shows they expect even more depreciation. In our family business, almost all imported equipment prices are now quoted in dollars, hinting at a rise in dollarization.


Economic analysis is supporting these “animal spirits.” Looking at the deviation of the real exchange rate from its long-term average, in terms of trade, expected change in net commodity exports as share of GDP and average inflation, economics consultancy Capital Economics finds that the lira is the currency most prone to further depreciation, even though Turkey is not even a net commodity exporter.

The lira’s slide will eventually come to a halt when the Central Bank has to raise interest rates significantly in an emergency meeting just like in January 2014. I just don’t know if that will happen soon, or when the lira-dollar exchange rate is 3.30-3.35, as Toronto Dominion Bank’s Christian Maggi expects it to be in four to 10 months, or somewhere in between.