Waiting for current account improvement in Turkey

January 6, 2014

The fall in Turkey’s lira to record lows is raising jitters among foreign investors who will have lost a good deal of money on the currency side of their stock and bond investments.  They are also worrying about the response of the central bank, which has effectively ruled out large rate hikes to stabilise the currency. But can the 20 percent lira depreciation seen since May 2013 help correct the country’s balance of payments gap?

Turkey’s current account deficit is its Achilles heel . Without a large domestic savings pool, that deficit tends to blow out whenever growth quickens and the lira strengthens . That leaves the country highly vulnerable to a withdrawal of foreign capital. Take a look at the following graphic (click on it to enlarge) :

In theory, a weaker Turkish lira should help cut the deficit which has expanded to over 7 percent of GDP.  Let us compare the picture with 2008 when the lira plunged around 25 percent against the dollar in the wake of the Lehman crisis. At the time the deficit was not far short of current levels at around 6 percent of GDP.  By September 2009 though, this gap had shrunk by two-thirds to around 2 percent of GDP.

An IMF paper at the time praised Turkey’s response, noting that allowing the lira to weaken had limited the country’s 2009 economic contraction to less than 5 percent compared to the 8 percent fall that would have been the case, had it held the lira stable.

That adjustment is yet to happen this time – the deficit stayed almost unchanged over 2013 despite the currency’s steady depreciation against the dollar. But perhaps these are early days.

Nima Tayebi, a portfolio manager for emerging currency and debt at JPMorgan Asset Management, notes that in the wake of  Turkey’s devastating 2001 financial crisis,  the lira (in its previous denomination) plunged to around 1.8 million against the dollar, after which the country gradually swung from deficit into small current account surpluses:

The lira adjustment has been significant and that’s one of the best ways to lead to an adjustment of the current account deficit. It should reduce import demand that will ultimately filter through to the current account.  After 2001 foreign investor sentiment was very fragile but given the (asset) valuations and the surplus they were running, the economy did heal itself. So possibly, the currency interventions are more to smooth the depreciation rather than to draw a line in the sand.  Slowly the currency is doing their work for them.

Benoit Anne, head of emerging market strategy at Societe Generale reckons however that Turkey’s current account gap is unlikely to contract significantly in the near-term, given buoyant credit demand among consumers. But the plus is that the lira’s real effective exchange rate (REER) — its exchange rate against a basket of trading partners’ currencies and adjusted for inflation — has weakened around 10 percent off highs.  That should ultimately help, he says.

The downside of course is the inflation pass-through. Inflation is running around 2 percentage points above the central bank’s target and further currency weakness could start to elevate that further — perilous for a government that faces elections next year.  Also,  any reduction in the deficit is likely to come through via falling imports — with global trade in the doldrums,  a weak currency is at best a blunt tool in the mission to aid economic recovery.



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