Investors fear premature interest rate cuts and chill in US relations, pushing the lira to near its record low.
Turkey’s lira has edged lower in early trading, adding to a recent slide and nearing an all-time low as a chill settled on relations with the United States and after the new central bank chief signalled that interest rate hikes would harm the economy.
The currency, among the worst performers in emerging markets this year, touched 8.425 versus the US dollar on Monday, nearing its low watermark of 2021 and close to its record 8.58 reached in early November.
“Market negativity is intense. (The) risk of an overshooting episode is unfortunately elevated,” said Robin Brooks, the chief economist at the Institute of International Finance.
The lira has shed 3.5 percent in the last three trading days as it became clear that US President Joe Biden would officially recognise the 1915 killings and deportation of Armenians in the Ottoman Empire as a genocide.
Turkey, a NATO ally of the US, sharply criticised the White House’s decision, which was announced on Saturday and said it undermined trust and friendship.
Turkish assets are particularly sensitive to strains in relations with Washington due to the fallout from US sanctions and economic threats, including a dispute in 2018 with then-President Donald Trump that sparked a lira crisis and recession.
President Recep Tayyip Erdogan’s spokesman and adviser, Ibrahim Kalin, told the Reuters news agency that Washington should act responsibly since it was in no one’s interest to “artificially undermine ongoing relationships for narrow political agendas.”
“Everything that we conduct with the United States will be under the spell of this very unfortunate statement,” he said in an interview on Sunday.
Adding to investors’ jitters, Turkish Central Bank Governor Sahap Kavcioglu, who was appointed a month ago, said late on Friday that while he would keep monetary policy tight, for now, any rate hike would send a bad message for the real economy.
“Who is happy with high interest rates?” he said in his first televised interview as bank head.
The lira has dipped for the last six straight trading days.
It plunged as much as 15 percent after Erdogan last month sacked Naci Agbal, a respected policy hawk, as central bank governor and appointed Kavcioglu, who – like Erdogan – is a critic of tight monetary policy and has espoused the unorthodox view that it causes inflation.
Agbal had raised the central bank’s benchmark policy interest rate to 19 percent to curb inflation that has risen above 16 percent and is expected to hit 18 percent. Many foreign investors who snapped up Turkish assets under Agbal sold them when he was fired.
Analysts expect the central bank to begin cutting rates by mid-year and some predict Kavcioglu could revert to a costly policy, conducted before Agbal was appointed in November, of selling foreign currency (FX) reserves to support the lira.
The political opposition has pressed Erdogan and his ruling AK Party to account for some $128bn in FX sales in 2019 and 2020, which were made by state banks and backed by central bank swaps, sharply depleting its FX reserves.
In the interview, Kavcioglu defended the sales in the face of what he called “attacks” that began with the 2018 crisis.
The lira’s depreciation could have gotten out of control and borrowing costs would have soared if authorities had not intervened last year, Kavcioglu said.
“You need to meet the FX demand of last year,” Kavcioglu said. “If you don’t, Turkey would have to face the consequences.” He cited corporate bankruptcies during a financial crisis 20 years ago as examples of how bad things could get.
Opposition parties put the blame for the drop in reserves on Berat Albayrak, Erdogan’s son-in-law who served as the treasury and finance minister for more than two years until stepping down in November.
Kavcioglu said reserve policies have been in use since 2017 when a protocol signed between the central bank and the Treasury enabled such unannounced foreign-currency interventions.
Turkey’s total gross reserves, including gold and money held by the central bank on behalf of commercial lenders, have dropped by more than 15 percent from the start of 2020 to $89.3bn in April. Net international reserves fell by more than 75 percent to $9.9bn, while money borrowed from banks under short-term swaps reached tens of billions of dollars.
With the swaps stripped out, net reserves would fall below zero, according to calculations by the Bloomberg news agency.
Kavcioglu “seemed quite confident about the quality of reserves, saying (they) were only shifted from assets to liabilities,” said Ozlem Derici Sengul, the founding partner at Spinn Consulting. But “losing assets and holding liability means the system remains quite fragile against a situation like a bank run where households and companies need their FX deposits,” she said.
Erdogan has fired three central bank chiefs in two years, eroding monetary credibility among foreign investors.
Saturday’s move by Biden fulfilled a 2020 campaign promise by the Democrat to Armenian-Americans but risks pushing Turkey further into Russia’s orbit.