Written by Jameel Ahmad, Global Head of Currency Strategy and Market Research at FXTM
Global currency markets are eyeing the volatile Turkish Lira which recently became one of the first emerging market currencies to show a red flag and decline during periods of USD strength. The main reason for this is basic economics. In the first quarter, Turkey entered a technical recession, meaning its economy is shrinking instead of growing. The symptoms of a shrinking economy can be diverse and unpredictable. In Turkey’s case, its currency is depreciating rapidly which undermines other closely linked financial instruments like sovereign bonds and wider economic activity in the business sector and households.
Beginning with the business sector, Turkish companies face profitability challenges because of the weakened Lira and softer investment confidence. External borrowing options are sparser for Turkish businesses some of which already carry high levels of debt in USD or EUR. Borrowers are finding difficulties in repaying foreign-currency loans because the local currency exchange is much weaker this year. This leads to less investment in new projects jobs and means higher unemployment. During February, the unemployment rate in Turkey rose to 14.7 percent, the highest level in nearly a decade. Paying out more unemployment benefits means a burden on fiscal spending.
As part of its measures to escape recession and in a timely move, Ankara appears ready to spend its way out of the economic hole. It recently announced a $4.9 billion financing package for exporters of raw materials, high-tech equipment and agricultural goods. The plan could go part of the way to balance out the economic headwinds because Turkish exports are competitively priced due to the weak Lira.
On the other hand, cheaper financing to exporters could end up costing the state in terms of national debt, higher fiscal spending and credit risk exposure. A lot depends on the results of these measures. If fiscal spending measures help to boost economic growth this year, the stimulus could be worth it in the short term but state spending has already reportedly soared by 135% for the period ending April 2019, considerably widening the budget deficit. When added to the repayment costs of servicing sovereign debt, Ankara faces the prospect of higher state budgets and borrowing costs dragging on development projects.
Other pressures on Turkey’s economy come from external factors like uncertainty over trade negotiations between the US and China. At the time of writing, the ongoing tariff disputes have raised the possibility of a global slowdown and the prospect of more headwinds for Turkey’s economy. The country’s central bank has been forced to take a hawkish stance despite the weaker economic growth and has been struggling to control high inflation rates with stiff interest rates, meaning that local businesses face considerable repayment fees which are likely to impact negatively on company profits and job creation.
External and internal challenges may prevail for the rest of the second quarter and even into the third quarter. The Lira is likely to stay under pressure and go through more dips depending on USD strength and investor confidence levels. However, more bright spots may emerge for Turkey and other emerging market economies if US-China trade talks result in a lasting deal to calm external headwinds and fears over global growth.
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