As lira continues fall, Turkey finds itself in a trap
With a majority of corporate debt denominated in foreign currencies, letting the lira find its own value poses systemic risks
The Turkish lira traded around 4.37 at the end of the New York session, a hair’s breadth below its intraday low last week and a lowest-ever daily close. The Turkish central bank should raise interest rates drastically – market chatter mentions a 2% hike – but as the collapsing Argentine peso showed last week, even a drastic increase in interest rates won’t necessarily help.
Turkey is in a trap: Most of its corporate debt is denominated in foreign currencies (roughly equally split between dollar and euro), so the cost of debt service rises as the lira depreciates. A conventional solution would let the lira find its own value; the currency certainly seems overvalued, which is to say that the actual price level has risen much faster than the official inflation data indicated. The trouble is that a free-fall in the currency would lead to a wave of corporate bankruptcies, and corporate bankruptcies would reduce the credit quality of Turkish banks – the same banks that have borrowed a net US$60 billion on the short-term interbank market.
If Turkish banks can’t roll over their interbank positions, Turkey’s foreign exchange reserves of US$83 billion (as of March 31) would be gone in a heartbeat, and the country would have to throw itself upon the mercy of the International Monetary Fund. The likelihood is that further lira depreciation will lead to a severe recession after the credit-fueled boom of 2017.
Asia Unhedged is still a seller of Turkish lira. Turkish stocks have lost 26% of their value on the Istanbul 100 Index since the September 7 peak, and are trading at a forward P/E of just 6.43 – but we advise against trying to catch the falling knife.