Turkey’s policy response insufficient to stabilize Lira, says Fitch

Turkey’s ‘incomplete policy response’ to the recent tumble in the lira was unlikely on its own to stabilise the currency and economy for a meaningful amount of time, Fitch Ratings said in a statement Friday

The rating agency said the policy response was insufficient, and that Turkey’s policymakers need to boost the credibility of their policy actions and independence of the central bank, as well as tolerate weaker growth, if they are serious about restoring economic stability and sustainability.

“We believe this would require an increase in the policy credibility and independence of the central bank, tolerance of weaker growth by policymakers, and a reduction in macroeconomic and financial imbalances,” it said.

The Turkish lira recovered somewhat last week after falling below TRY7 to the dollar, but is still down around 35 percent against the dollar in the year to date. Foreign exchange reserves (including gold) equally dropped to USD96.8 billion at end-June from USD110.4 billion at end-April.

The Central Bank of the Republic of Turkey raised the effective interest rate by 1.5 percentage points, Fitch noted, by providing liquidity at the overnight interest rate of 19.25 per cent rather than its main policy rate of 17.75 percent. The country’s regulator has also restricted short selling of the lira, and Qatar had also pledged to invest $15 billion in the country, although the plan is scant on details.

Those efforts have helped stabilise the lira, but Fitch said “an ad hoc and incomplete policy response cannot fully address the underlying causes of the lira’s fall, namely the large current account deficit and external financing requirements, the jump in inflation (to 15.9% in July), the build-up in foreign currency debt, and deterioration in economic policymaking credibility.”

These expose Turkey to global issues such as a strengthening US dollar, rising US interest rates and trade wars.

Exposure to such risks was a key reason why Fitch decided last month to downgrade Turkey’s sovereign rating to BB from BB+.

In Fitch’s view, evidence of an appreciation of and genuine commitment to orthodox monetary policy from the top of the Turkish administration, and greater detail on policy measures in the new administration’s economic agenda, plus a track record of implementation, are likely to be required to restore lasting market confidence.

The rating agency further said that bilateral support such as that pledged by Qatar is unlikely to meet Turkey’s external financing requirements without a sustainable policy adjustment.

“We estimate Turkey’s gross external financing requirement at $229 billion in 2018 (including short-term debt), well in excess of official foreign exchange reserves,” it noted, adding markets appear to believe that only a further increase in the main policy interest rate (which has already been raised by 500bp since April) would establish a sufficient real rate reflective of the risk premium, demonstrate policy credibility, support disinflation, re-establish a nominal anchor and attract capital inflows.

Fitch noted that the abrupt tightening in financial conditions will sharpen the slowdown in GDP growth already under way. A slowdown from 2017’s unsustainable 7.4% growth and some depreciation of the real exchange rate were inevitable to reduce imbalances.

“Turkey’s vibrant economy and favourable medium-term growth potential support sovereign creditworthiness, as does low government debt (28% of GDP at end-2017, of which foreign-currency debt was only 11% of GDP).

“But the absence of an orthodox monetary policy response to the lira’s fall, and the rhetoric of the Turkish authorities have increased the difficulty of restoring economic stability and sustainability.”