Summary:
By: Richard Russell
Tags: Investing, Turkey, Finance, Trading

Summary:

CAATSA sanctions were applied on Turkey’s defence industry for its S-400 purchase. These were light, however the story isn’t over. CBRT Governor Agbal gave his presentation of the Monetary and Exchange Rate Policy for 2021. He reiterated the bank’s inflation targeting mandate, and said the bank will look to rebuild FX reserves in 2021. The CBRT meet on Thursday, market pricing is for 150bps of hikes. I expect 200bps given high and accelerating inflation, and the need to maintain market credibility. Flow data showed that offshore investors bought $140m of Turkish securities in week ending 11th December, with dollarisation of domestic deposits slowing.

CAATSA sanctions have been levied on Turkey’s Presidency of Defense Industries, as well as members of its staff. These are light, but the story isn’t over.

On Monday the US formally announced CAATSA sanctions in response to Turkey’s purchase of the S-400 missile system from Russia, with this fact having been released to news agencies last week. As expected, these sanctions are on the lower end of the severity scale, with the financial sector and real economy in Turkey likely to be unaffected by these targeted sanctions.

These sanctions are the first step towards the resolution of the S-400 issue, with my expectation that an agreement will be reached that sees the S-400s mothballed, and that they will never be made fully operational. There is strong bipartisan consensus in Congress, and amongst NATO members, that Turkey needs to give up the S-400s. These sanctions will not be enough to force Turkey to renounce the missiles, and I expect to see a move towards further sanctions towards the end of 2021 as an attempt to push Turkey to give up the S-400s.

It is widely expected that Biden will re-engage with America’s overseas allies upon assuming office, with presenting a united front against Russia and China likely to be part of his plan for a recommitment to multilateralism from America during his Presidency. Biden will have to decide how to re-integrate Turkey into the NATO alliance. My sense is that the bad blood that’s been building between America and Turkey will force Biden to continue with a more robust stance towards Turkey, I also think that Erdogan will reduce his antagonism towards the new administration if he senses that there will be more forceful consequences for his actions.

Governor Agbal’s presentation on policy in 2021 stated that the CBRT will maintain tight monetary policy, and will seek to rebuild FX reserves.

The CBRT released their Monetary and Exchange Rate Policy document for 2021 on Wednesday, and Governor Agbal gave a presentation and answered Q&A. The document reiterated the recent commitment from Governor Agbal to maintain a tight monetary policy stance until a permanent fall in inflation in Turkey is achieved, and that monetary policy in 2021 will be conducted in a manner consistent with this aim.

The Governor also said that the CBRT will be looking to rebuild FX reserves in 2021. The rediscount credit usage and repayments of reserves are projected to add about $21bn to the CBRT’s FX reserves in 2021, and the Bank will also be active buying back USD via auctions. The report states that the the Bank ‘may hold FX buying auctions via transparent methods according to a schedule with pre-announced rules’, so we should not expect to see the CBRT on the bid in USDTRY, but rather they will pre-announce they will be looking to buy USDs instead of ad hoc purchases.

Overall the report and presentation were a bit of a non-event, there was a continuation of recent messaging that CBRT policy will continue to be tight in 2021 to try and bring inflation under control, and there were no material changes to policy announced. Thursday’s CBRT meeting will be a better indicator of future policy than this report.

The market is pricing 150bps of hikes for the CBRT meeting on Thursday, I expect to see 200bps.

Inflation in Turkey is high and rising, which will force the CBRT to continue its rate hikes at their meeting on Thursday. I also expect to see another rate hike from the Bank at their 21st January meeting. PPI has accelerated rapidly since the summer months, with the print for November showing a 23.11% YoY rise in Producer Prices. This rise in PPI, combined with the seasonal higher inflation in winter will push CPI above 15% in Q1, which the CBRT will want to get in front of by hiking rates on Thursday.

Source: Bloomberg

The composition as well as the outright level of inflation should also worry the CBRT. The chart and table below from the CBRT’s policy report show that the main contributors to inflation are currently Core Goods and Food and Non-Alcoholic Beverages, both of which are currently in a sharp uptrend since the summer months.

In addition, the CBRT’s recent rhetoric regarding a change of monetary policy stance and the need to decisively tighten monetary policy to combat inflation mean they will have to raise rates on Thursday. If the repo rate remains unchanged, they will lose significant credibility in the eyes of both foreign investors and more importantly domestic savers. Domestic dollarisation has slowed but not stopped, and foreign investor inflows into Turkish assets have slowed since mid-Novembers highs. No change on Thursday will restart domestic demand for USD and gold, while also making foreign investors less bullish on Turkish assets.

Flows data show both a small increase in local FX deposits, and small foreign inflows into Turkey’s asset markets in the week ended 11th December.

CBRT data showed an increase of $167mn in domestic FX deposits in the week 4th December — 11th December, and an inflow to Turkish bond and stock markets from foreign investors of $140mn. The slowdown in FX purchases by domestic savers is encouraging, however there is still a lot of work to be done by the CBRT on this front, with over 50% of Turkish deposits in FX. In addition, the small inflows into asset markets show that the CBRT and economic policy makers in Turkey must continue to create a positive investment environment in Turkey.

I expect that 2021 will see a decrease in FX deposits in Turkey, with the removal of the asset ratio rule on 31st December set to allow banks to offer higher Turkish lira deposit rates to savers, and a tighter monetary stance from the CBRT also likely to encourage domestic savers to hold lira deposits. Banks in Turkey have begun raising deposit rates following the recent repo rate hike, however they are still shackled by the asset ratio rule into lending, buying TurkGBs, or conducting FX swaps with the CBRT if they take in deposits, which is keeping deposit rates down.