A tough task to keep hot money out

In the past few days we have witnessed yet another bout in the exchange rate, as the U.S. dollar spiked up to over 1.80 Turkish Liras. The seriousness of the situation was confirmed yesterday, with the Turkish Central Bank declaring it an “extraordinary day” - meaning no lira liquidity into the market via the one-week repo rate, which stands at a historic low of 5.75 percent.

The move comes amid signs that Turkey’s energy import bill will remain high due to the ongoing regional tension. For many, the current Brent crude price of just below $124 per barrel is “low” considering the level of political strain in the Persian Gulf. Unfortunately, 45 percent of Turkey’s trade deficit stems from energy imports, and we have been able to find a magic cure.

Thus, for the main actors of the economy, it remains to be seen whether the inevitable “correction” in the balance of payments will be gradual or sudden. As the Central Bank announced its measures, I was speaking with Kelvin Tay, the Singapore-based chief investment strategist of UBS. What will happen regarding the exchange rate was one of the most-asked questions during the few days he was in Istanbul.

Tay’s advice was straightforward indeed: in these times of abundant global liquidity thanks to major central banks’ actions, Turkey should make sure it “does not attract too much hot money.” His chief concern seems to be the too-high appreciation of the Turkish currency, which reminds us of recent policies implemented by other emerging economies, such as Brazil.

Brazilian President Dilma Rousseff has mentioned a “tsunami” of foreign capital that props up the real’s value, thus hurting the vital export sector. According to recent news reports, the government is considering the early repayment of up to $15 billion of its external debt issues in an effort to weaken the real.

Of course, the issue essentially stems from the easy money policies of major central banks, which until today have forced American and European investors to put their cash elsewhere.

But there could be another explanation for the appreciation of the dollar, as Akbank analysts emphasize in a note to investors yesterday. The positive data coming in from the U.S. economy and the diminishing expectation that a third round of quantitative easing is under way, have both created interest for the dollar, propping up the greenback. It definitely is a global trend - the dollar is trading at an 11-month high against the Japanese yen, for example.

Whatever the reason, Tay’s advice for Turkey is to “dissuade” hot money from flowing in, because when it eventually pulls out, it will cause major turbulence.

Though pleased with the European Central Bank’s liquidity operations, Tay seemed almost sure that Greece and maybe Portugal will have to exit the euro eventually. If that happens, “hot money” could quickly pull out of the Central and Eastern European markets, which have the strongest financial links to the euro area.

And though Turkey’s finances are fundamentally very different (in a positive way) from those economies, it unfortunately falls into that same geographical basket that today’s giant funds tend to view as being all the same. Thus, Tay does not think they will differentiate between the region’s markets when they pull out in a bout of panic. 

Evidently, we are entering a period in which policy makers should tread very carefully...