Sustained Crackdown Stokes Investor Flight From The Lira

The draconian measures undertaken by Turkish President Recep Tayyip Erdogan in the wake of a failed overthrow attempt have sent investors running for the exits as the crackdowns raises serious questions about doing business in Turkey and the government’s transparency. More concerning is the recent seizure of private assets and properties belonging to Erdogan’s local opposition that came as a result of the “temporary” 3-month state of emergency decreed by Erdogan in response to the coup. While the Lira has been able to recover moderately since plunging to new record lows against the US dollar, diminished confidence in the leadership combined with falling revenues in key industries could rapidly challenge the country’s financial position. Additional ratings downgrades and reduced capital flows will mean more precarious economic conditions for the nation in the months and years ahead.

Deteriorating Backdrop

Turkey has been finding itself increasingly isolated over the years as the bellicose rhetoric of firebrand President Erdogan polarizes the political conditions domestically while offending allies and enemies alike. Erdogran’s increasing grip on the government and vision of himself as a modern day sultan has not only earned him disdain at home, but also throughout Europe, which is rapidly reversing its plans to include Turkey in the European Union. As the latest crackdown against political opponent shows, transparency and fairness are not part of the equation for the leadership. Although Turkey has managed to drastically improve the functioning of the economy, however, the latest moves threaten to undo all that progress. A ratings downgrade from S&P combined with lessened foreign direct investment have already negatively impacted the Turkish currency, with any further action likely to spur another round of Lira depreciation.

One of the byproducts of the latest deterioration in the Turkish Lira is heightened upside pressure on inflation dynamics. Turkey historically has suffered demonstrably from higher inflation, which speaks volumes to the embrace locally of holding gold as a hedge against the gradually reduced buying power of the Lira. Alongside an accommodative Central Bank that has eased lending rates in each of the last five monetary policy decisions, dropping the rate from 10.75% back at the beginning of the year to 8.75% where it currently sits. However, despite the increased accommodation to help jumpstart lending and the economy, inflation still remains extraordinarily high at 7.64%, well above the Central Bank’s 5.00% target.While helpful to offset the damage done to certain industries over the last year, it will not be enough to restore a critical component of the economy which is tourism.

A spate of terrorism over the last year has created numerous problems for Turkish policymakers as they work hard to maintain their crucial tourism industry. Not only is the industry important from the standpoint of bringing in foreign currency to help pay the current account deficit, but considering it significant role in economic activity, any serious decline in visitors could severely impact growth and unemployment which is now hovering near 9.30%.Between the incident in the airport the during the prior month and other attacks against both civilian, government, and military infrastructure, the growing threat of extremist elements will undoubtedly negative impact the industry and dash any hope of an imminent recovery. When taking all these points of view together, it is challenging to see an environment where the Lira has any upside, with existing pressures all working against the Turkish currency.

Technically Speaking

After spending a significant period of time consolidating, the USDTRY is once again on the rise, benefiting from the recent Turkish turmoil which has propelled the pair to new record highs over the last week. The breakout from the triangle consolidation formed by the combination of the longer-term uptrend and medium-term downtrend was accompanied by significant volume and momentum higher, indicating a directional move and potential continuation of the trend higher. Adding to the upside case for USDTRY is the recent moving average crossover. The 50-day moving average crossing the 200-day moving average to the upside is traditionally viewed as a bullish sign, with both moving averages now acting as support as they trend beneath the USDTRY price action. Should continue its trend higher after a brief pullback, a newly emergent upward trend could form the basis for the price action of the next few months.

Looking Ahead

With much hanging in the balance as the crackdown against political opposition persists, Turkey is likely to see the economy regress further as investor confidence worsens. Although the Lira has managed to catalyze a relief rally following recent losses, the pullback in the USDTRY pair may be nothing more than a technical correction for a new upward trend that is in the early stages of formation. Besides the loosening of monetary policies which is likely to spur further losses in the Lira, more centralized political control and greater fiddling with the economy via government intervention may spell decreased foreign direct investment. Furthermore, if tourism fails to recover, the stage may well be set for a precipitous economic decline in Turkey, sending USDTRY to new record highs.