Not much new here, but a good summary nonetheless.
April 28 (Bloomberg) — For proof that Turkey’s economy and the government of Prime Minister Recep Tayyip Erdogan may be unraveling, look no further than the lira.
The ruling Justice and Development Party touts the lira’s growing “prestige” on its Web site following the currency’s record 21 percent rally in 2007. Those gains are evaporating as inflation and political instability grip the Muslim nation of 72 million seeking membership of the European Union. The lira has fallen 8.4 percent against the dollar this year, to 1.2785.
Once-bullish traders lured by a benchmark interest rate of 15.25 percent are dumping the currency as the Constitutional Court weighs an attempt to remove Erdogan and his government from office. The decline is undermining the central bank’s efforts to curb inflation, which rose at a 9.2 percent rate in March, more than any member of the EU. Merrill Lynch & Co. and JPMorgan Chase & Co. recommend investors either avoid or reduce their holdings of Turkish assets.
“It’s not going to be a good year for the lira because of deepening political uncertainty and global risk aversion, which primarily hurts countries with big current-account deficits,” said Yarkin Cebeci, an economist in Istanbul at JPMorgan.
The lira’s decline since January is more than all emerging- market currencies except the Icelandic krona, which is down 12 percent, and the South African rand. Trading in options shows the lira, a bellwether for emerging markets, will be the second- riskiest currency to own over the next 12 months after the rand.
A law that would allow university students to wear Islamic- style headscarves, backed by the party this year, has triggered charges by Chief Prosecutor Abdurrahman Yalcinkaya that Justice’s Islamist roots threaten Turkey’s secular system.
Closing the ruling party and banning Erdogan and President Abdullah Gul from public life for at least five years may mean a return to fractious coalition governments that helped spark a financial crisis in 2001, Jean-Dominique Butikofer, who helps manage about $725 million as head of emerging-market debt at Union Bancaire Privee in Zurich, said in an interview with Bloomberg Television this month. Justice won last year’s elections with 47 percent of the vote, more than twice that of its nearest rival.
The risk is that political conflict will distract the government from containing inflation and reducing the budget deficit as called for under its $10 billion loan agreement with the International Monetary Fund, according to Ilker Domac, an economist in Istanbul at Citigroup Inc. The accord, which helped Turkey achieve annual growth of about 7 percent, expires next month.
“The recent political developments are likely to complicate policy-making and the investment climate,” Domac said. “The deteriorating political backdrop will in turn undermine the prospects for restoring fiscal discipline and reviving the reform agenda.”
The lawsuit may jeopardize Turkey’s EU bid, which has underpinned investment and economic expansion. Justice, which is contesting the ban, has presided over 24 consecutive quarters of growth, attracting a record $58 billion of foreign capital.
The EU’s foreign policy chief, Javier Solana, said on April 8 the lawsuit was a “grave” risk to the membership and overturning a legitimate election result would be a violation of European norms.
The lira fell 2.5 percent on March 17, the biggest decline in seven months, after the lawsuit was presented March 14. A day later, Merrill Lynch reduced the amount of 10-year Turkish bonds in a model emerging-markets debt portfolio to 7.4 percent from 9.9 percent.
Closure of political parties is nothing new to Turkey. The court shut down two predecessors of Erdogan’s party in 1998 and 2001 on similar charges.
“Turkey has always been a risky place, but high returns are the pay-off for those who take the risk,” said Michael Ganske, a strategist in London at Commerzbank AG, Germany’s second-biggest lender. While investors are inclined to bet against the lira, “we expect Justice eventually to stay in place” and foreign direct investment “to underpin the currency,” he said.
The lira may advance to 1.25 per dollar by year-end, he predicted. JPMorgan’s Cebeci said it may weaken to 1.40 before rebounding to 1.32 by the end of the year.
JPMorgan on March 28 cut Turkish bonds to “underweight,” meaning it recommends investors hold a smaller percentage of the securities than contained in benchmark indexes, from “market weight.” Standard & Poor’s changed its outlook on the nation’s BB- credit rating to “negative” from “stable” on April 4, indicating a downgrade is the most likely next step.
“No one knows how the political situation will evolve, how much time it will take the court to decide or what the verdict will be,” said Turker Hamzaoglu, an economist in London at Merrill Lynch. “The political tension coincides with a global crisis in financial markets, and this all weighs on the Turkish currency and assets.”
Investors’ aversion toward the lira has caused the price of imports to rise. That’s created a conundrum for policy makers, who are stuck between a slowing economy and faster inflation.
The Central Bank of the Republic of Turkey said March 31 it would avoid “tough” measures for fear of damaging the economy, which grew 3.4 percent in the fourth quarter, the slowest in more than five years.
Policy makers have cut their benchmark rate by 2.25 percentage points since September, dimming the allure of the nation’s interest-bearing assets and damping demand for the lira. A weaker currency may make it more difficult to finance the current-account deficit, which the central bank said widened to a record $37.4 billion in 2007.
Foreign investors have withdrawn $6 billion in “the past few months,” Sabah newspaper said on April 3, citing a report by the Banking Regulation and Supervision Agency. The stock market’s capitalization has fallen to $197 billion, from $282 billion in December, Bloomberg data show.
Still waiting on Eastern Europe …