Lira crisis: action by Turkey’s central bank fails to quell contagion fears

Euro falls to one-year low as investors worry liras crash could infect European markets

Asia

The Turkish lira was under severe pressure on Monday as an intervention by the countrys central bank, and defiant words from president Recep Tayyip Erdoan, failed to to quell investors fears that the countrys financial crisis could spread to European markets

The lira pulled back from a fresh record low overnight, when it fell around 9% to 7.2 lira against the dollar, after the central bank pledged to provide liquidity for Turkish banks and give them more breathing space by cutting their lira and foreign currency reserve requirements.The euro was also hit a one-year low against the dollar, reflecting fears of contagion for the European banking sector.

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However, the liras recovery in afternoon trading remained weak – at 6.9 to the dollar – as president, Erdoan followed the central banks comments with a claim the US was trying to stab Turkey in the back.

Q&A

Why is the lira falling so fast?

Over the past five years, Turkeys growth has been virtually keeping pace with that of China and India, but is now displaying the classic signs of overheating: a large current account deficit, a construction boom and soaring debt.

Financial markets have taken fright at inflation, currently rising at an annual rate of more than 15% and have been selling the Turkish lira, which is down by 45% against the US dollar since the start of the year.

Two additional factors are exacerbating the crisis. Turkeys president, Recep Tayyip Erdoan, is opposed to raising interest rates to cool down the economy and support the currency, and has used his recent election victory to impose his unorthodox views on the countrys central bank.

The lack of interest-rate action has coincided with a marked worsening of Turkeys relations with the United States. Turkeys decision to hold an American pastor, Andrew Brunson, in house arrest of disputed terrorism charges, has prompted Donald Trump to impose sanctions and double tariffs on imports of Turkish steel and aluminium.

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Addressing Turkish ambassadors in Ankara, Erdoan said his country was under an economic siege but would overcome the attack on its economy. He insisted that Turkeys economy remained strong and said the lira would soon settle at the most reasonable level.

The Turkish authorities also launched investigations into hundreds of social media accounts for alleged reports they claimed were aiding the currencys plunge.

Turkeys central bank pledged to provide all the liquidity the banks need. It added: [We] will closely monitor the market depth and price formations, and take all necessary measures to maintain financial stability, if deemed necessary.

Lira v US$
Lira v US$

However, the Ankara-based bank has not raised interest rates, which some economists argue is necessary to alleviate the crisis because it will curb inflation and deter investors from selling the lira. Erdoan has warned against raising borrowing costs.

The Turkish finance minister, Berat Albayrak, who is Erdoans son-in-law, said at the weekend that authorities would start implementing an economic action plan on Monday morning. He rejected capital controls as an option to stem outflows of hard currency.

Following his comments, Turkeys banking regulator announced late on Sunday that it would limit the ability of the countrys banks to swap the lira for foreign currency.

Investors are concerned about the exposure of European banks, including Spains BBVA, Italys UniCredit and Frances BNP Paribas, which have big operations in Turkey. European bank shares had dropped 1% by Monday afternoon.

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The FTSE 100 was down 0.4% on Monday afternoon, with Germanys Dax down 0.4% and the CAC in Paris trading flat in the wake of heavy losses in Asia overnight.

Turkish inflation chart
Turkish inflation chart

The Turkish stock market lost 3.5%, with some bank stocks suffering double-digit losses. The Russian rouble, South African rand and the Mexican and Argentine pesos other emerging currencies that could be at risk also fell.

Fiona Cincotta, a senior market analyst at City Index, warned that the slump in the lira could prompt some companies to default on their US dollar loans, triggering a domino effect.

For the time being Turkeys financial crisis looks localised but the countrys central bank has perhaps only days to stop the decline of the currency before the liras freefall results in loan defaults, starts seriously affecting the countrys financial system and potentially starts spilling over on to European banks.

Central bank currency reserves

The falling lira fuelled demand for safe havens, including the greenback, Swiss franc and yen. The Vix volatility index measuring turbulence in financial markets also known as the fear index jumped 16%.

The lira has tumbled more than 40% this year on worries about Erdoans increasing control over the economy and worsening relations with the US, chiefly over the war in Syria.

The US sanctioned two ministers in Erdoans government in a spat over the continued detention of an American pastor in Turkey, and doubled tariffs on Turkish steel last week.

While the Trump row helped trigger a run on the lira last week that continued on Monday, the market moves against the Turkish currency reflect deeper problems for one of the worlds largest emerging economies. Turkish companies have made significant borrowings, including large amounts in dollars, and have raised $220bn (172bn) in debt which has become more expensive to repay as the lira has fallen.

The central bank is under pressure to increase borrowing costs despite Erdoans misgivings as a countermeasure against rising inflation and capital flight. However, some economists warn this could also push Turkey into a recession.

European banks’ exposure to foreign debt
European banks exposure to foreign debt

Andrew Kenningham, the chief global economist at Capital Economics, said: The plunge in the lira, which began in May, now looks certain to push the Turkish economy into recession and it may well trigger a banking crisis.

This would be another blow for emerging markets as an asset class but the wider economic spillovers should be fairly modest, even for the eurozone.

On Sunday Erdoan accused foreign countries of waging war on Turkey and said his government would respond with trade measures to reduce reliance on the dollar and US markets.

Original Article : HERE ; This post was curated & posted using : RealSpecific

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