In the selloff gripping emerging markets, one currency is conspicuous by its absence — the Turkish lira. But this will change unless the central bank adds significantly to its successful lira-defensive measures.
Hopefully at today’s policy meeting.
Like India or Indonesia which have borne the brunt of the recent rout, Turkey has a large current account deficit, equating to over 5 percent of its economic output. But what has made the difference for the lira is the contrast between the Turkish central bank’s decisive policy tightening moves and the ham-fisted tactics employed by India and Brazil. (We wrote here about this). See the following graphic (from Citi) that shows the central bank has effectively raised the effective cost of funding by 200 basis points to around 6.5 percent since its July 23 meeting.
Guillaume Salomon, a strategist at Societe Generale calls Turkey the “success story” given the relatively stable lira and expects the bank to raise the upper band of its interest rate corridor by another 50 basis points at least. He says:
India and Turkey are in a similar situation but one central bank’s approach has worked and the other one hasn’t. They have made it punitive to go against the lira and people have given up. I am happy to hold lira because when if the currency comes under pressure, I will be rewarded with higher short-term (interest) rates. A rate hike now will be a signal that they are watching the currency and will allow short-term rates to go higher.
Today will therefore be decisive for the lira. Unless Governor Erdem Basci raises the upper end of the interest rate corridor again or at least pledges further significant tightening of monetary conditions, the lira may well join the selloff. Interest rates in Turkey are still too low given the scale of the global selloff and rising domestic inflation (many analysts predict inflation to hit 10 percent by end-2013).