Data show the scale of task confronting the CBRT
By: Richard Russell
Tags: Turkey, Finance

Inflation data paint a grim picture for the CBRT

This week saw CPI and PPI data released in Turkey, with CPI accelerating to 14.03% YoY, and worryingly PPI also accelerated to 23.11% YoY as the delayed impact of currency depreciation continued to put upwards pressure on prices. Inflation dynamics in Turkey are also negative, with the winter months seasonally putting upward pressure on Turkish inflation. CPI should continue to tick up into Q1, where it is likely to be above 15%, testing the CBRT’s credibility and likely forcing them to continue to hike rates.

I think this inflation data makes a rate hike at the 24th December CBRT meeting almost a certainty, with the OIS market pricing around 150bps of hike at the meeting. The CBRT will need to continue to show firm action to retain the credibility they have regained in the eyes of market participants, with inaction in the face of accelerating inflation to be seen as very negative for the lira, and for foreign investor sentiment towards Turkey.

Preliminary current account data also very negative

November’s preliminary current account data were also very negative, with the current account deficit up 155% YoY to $5.07bn, the second largest monthly gap so far this year. Exports were roughly flat, but imports rose 16% as the last credit hurrah has continued to push up Turkish consumption, while the depreciation of the lira has yet to translate into greater exports for Turkey.

The data also highlight that Turkish savers’ lack of trust in the lira continues to be a major negative for the currency, with nearly all of Turkey’s current account deficit explained by imports of gold which have increased as Turkish savers have lost confidence in the lira and switched to gold and FX.

Some positive signs in the foreign investor flow data, and local deposit data

Flows data for the week ending 27th November showed foreign investors had invested $381mn across the Borsa Istanbul and TurkGBs, a significant inflow but down substantially from the peak flow over $1bn in the week ending 13th November after Albayrak’s resignation. Additionally, CBRT data for the week ending 27th November showed local FX deposits only increasing by $6mn, a positive sign for a slowdown in dollarisation.

The rates on domestic TRY deposit account also continue to rise, with a number of banks now offering 32 day bank deposit rates above the 14.03% official rate of inflation, however it should be noted that the interest on these accounts is subject to a 5% deposit tax.

Source: www.enuygun.com

Growth was also strong in Q3, as credit expansion lifted domestic GDP

Turkish Q3 GDP came in at +6.7% YoY, as credit expansion by state banks over the Q2 and Q3 period pushed growth up and GDP above its pre-coronavirus level, at least temporarily. This rebound will not be sustained, as renewed lockdown measures to fight the coronavirus second wave, tighter monetary policy due to CBRT rate hikes, and a withdrawal of the credit impulse will all combine to return Turkey into recession in Q4 of 2020 and Q1 of 2021. In addition, the negative economic situation in Europe due to its ongoing lockdowns will have a negative impact on the Turkish economy, as Europe is Turkey’s largest export destination.

Some mild sanctions from the EU and possibly US are likely in the near future

An EU Summit scheduled for 10th-11th of December will include some conversations about the possibility of sanctioning Turkey for its ‘provocative’ actions in the Eastern Mediterranean. A number of EU figures have said sanctions will be discussed, however the bloc has other important issues to deal with at the moment. Brexit negotiations are entering the final stage, Poland and Hungary are holding up the EU budget, and the situation in Belarus continues to rumble on. Given all the issues the EU is facing, it is unlikely that the EU will have the time or the will to come together for a comprehensive sanctions package on Turkey, with the most likely outcome being further rhetoric and a postponement of any sanctions until the new year.

In the US, Congress will vote on the annual defense policy bill that includes a clause that designates Turkey’s purchase of the S-400 missile system from Russia as a ‘significant transaction’ under the CAATSA legislation, which would mandate sanctions on Turkey in response. If the bill is passed in the next week then President Trump will be charged with choosing the sanctions, however if it is passed after that Biden will implement the sanctions in the new year.

Trump has already threatened to veto the bill, as he wants to use the bill as part of an attempt to rewrite liability laws for social media companies, however there is strong bipartisan support for the bill in Congress, with members of Congress having already said they will override any veto by Trump. There have also been reports in the Turkish local news (link) that Erdogan has asked Trump to enact CAATSA sanctions to prevent them being enacted by Biden.

Given all the issues going on within the EU and the US, I don’t expect to see strong sanctions on Turkey in the near future, the CAATSA sanctions story has been rumbling since Q3 last year, and the EU sanctions were also discussed at an EU summit in September with no outcome. I think the most likely outcome at this point is for some very mild sanctions, possibly against named individuals or firms within Turkey, and rhetoric saying that more is on the way if Turkey doesn’t change its ways. Longer-term, I also expect that the S-400 issue will be resolved without a return to crippling sanctions like Turkey experienced in 2018 during the Pastor Brunson crisis.

Despite all this, the outlook is positive for the lira

Even with all the potential negatives floating around, the outlook for the lira is still positive in my view. The new economic team will do what needs to be done to right the economic ship, Turkish assets are still under-owned by foreign investors, and the carry potential in the lira is still much greater than anything available in other large EM currencies.

The higher CPI numbers, while on the face of it a negative, will most likely sharpen the minds of new CBRT governor Agbal and Finance Minister Elvan, with a hike of 100–150bps likely at the 24th December CBRT meeting, and a further hike in January also probable given inflation dynamics will continue to push inflation higher into Q1. A lower print of say 12.5% may not have made it as clear that further action on the interest rate front is necessary, allowing the CBRT to pause and potentially leading to doubts creeping in about the CBRT’s commitment.

We should expect at least one more rate hike in the next two meetings, with this pushing rates up above 16%. This will further add to Turkey’s carry advantage over other EM currencies such as MXN, BRL, RUB, ZAR, which all have significantly lower carry. Turkey now has over double the volatility-adjusted carry of the next highest EM currency (Indonesian rupiah), according to Bloomberg, with volatility also falling given the recent reforms and likely to fall further based on 1yr option volatility pricing.

Source: Bloomberg

USDTRY 1 Year Option Volatility

Source: Bloomberg

Overall then the picture the is positive. Turkish assets are still under-owned by foreign investors, realities on the ground mean that economic reforms and tighter monetary policy will be carried out by the new economic team, the lira is supported by high (and getting higher) carry, as well as falling volatility levels.