Complex Made Simple

The Turkish Lira will fall to 10 against the US dollar in the next 3 years!

A devaluation of the Turkish Lira may appeal to real estate investors, but it comes with dire warning for Turkey’s Erdogan and his politics

The Turkish Lira is vulnerable to a speculative attack by offshore investors, even though it has fallen 43% since 2017 Inflation is 20% and rising and Turkey faces a systemic banking crisis, and an impotent central bank Erdogan has also mismanaged his relations with the US, Germany, Egypt, Saudi Arabia and the UAE

By Matein Khalid: Chief Investment Officer and Partner at Asas Capital

A currency volcano has erupted on the Bosphorus yet again. The Turkish lira has tanked to eight-month lows at 6.15 to the US dollar. Global investors have lost confidence in the political, economic and monetary policies of AKP President Recep Erdogan. The Election Council decision to annul the mayoral election in Istanbul has plunged the Turkish Republic into yet another political crisis. Foreign investors were also unnerved by the crackdown on J.P. Morgan after its currency strategists (rightly) recommended investors sell the lira and the Financial Times allegations that the Turkish central bank was using currency swaps with local banks to inflate its foreign exchange reserves. Once short term borrowing is stripped out, Turkish hard currency reserves have fallen to new 2019 lows at $27 billion.

Moodys has warned that the Turkish lira is vulnerable to a speculative attack by offshore investors, even though it has fallen 43% since 2017. A hard currency war chest of $27 billion is simply insufficient to defend the lira at a time when confidence has evaporated in the Istanbul and Ankara money markets. The Turkish central bank will no longer be able to intervene in the foreign exchange market to offset spasms of foreign panic selling – and the Turkish lira’s decline will accelerate into a free fall.

More by Matein: Is the Euro/dollar exchange rate headed down to 1.08?

Several friends in Dubai/Saudi have been enchanted by the optical “cheapness” of Istanbul real estate. While Istanbul has bewitched me since my boyhood, I believe that it is insane to invest in a country whose currency has lost 85% of its value against the US dollar in the past decade. If anything, the depreciation of the lira in the next decade will be even steeper since President Erdogan has concentrated political power via a constitutional amendment and abandoned the pro-Western veneer of his first decade in power.

The AKP government has also mismanaged the Turkish economy by allowing banks to recklessly expand their balance sheets. Erdogan even threatened to charge a former governor of the Central Bank of Turkey with “treason” if he dared to raise interest rates and hinted darkly about conspiracies of the international interest rate lobby to overthrow his regime. Erdogan believes high interest rates cause, not combat inflation and state bank lending is the solution to budget deficits. Erdogan deserves a Nobel Prize in economics science fiction for his brilliant insights!

The annulment of the March elections and the debate over the plunge in net reserves of the central bank have destroyed the last vestige of investor confidence in Erdogan’s economic governance and rationality. Erdogan has ordered a surge in pro-election bank lending to dampen the appeal of united apposition candidate Ekram Imamoglu of the Republican Party. A double dip recession this autumn is inevitable. Sovereign credit default swaps have surged to August 2017 levels.

Inflation is 20% and rising. Turkey faces a systemic banking crisis – and an impotent central bank. A nation with 24% policy rates kills capex. Turkey is vulnerable to an oil shock and a US-Iran war. The lira can easily fall to 10 against the US dollar in the next three years – and this is my optimistic forecast based on current relative inflation differentials.

More by Matein: Expert: Buy the Canadian dollar for a 1.30 tactical target with a tight stop!

International relations in the eastern Mediterranean reinforce my reluctance to own Turkish assets. One, Finance Minister Albayrak (Damad Pasha, the Presidential son in law!) just announced Turkey would send a natural gas drilling ship in disputed waters off the coast of Cyprus, the EU member island state Ankara invaded and eviscerated in 1974.

The Turkish Navy has also escalated the scale of Sea Wolf, its naval exercises in the Aegean Sea/Med. President Erdogan has also defied Washington’s diktat and bought Russian S-400 missile systems that endanger NATO collective security against the Kremlin. This means the Trump White House will have no choice but to impose economic sanctions on Turkey – F-35 Stealth bomber arms deal is now impossible. This fact is simply not reflected in the exchange value of the lira though it is conventional wisdom at the Pentagon and Langley.

Autocrats often respond to domestic threats with foreign aggression. This has been a recurrent theme in human history, from Benito Mussolini’s invasion of imperial Ethiopia, Saddam’s invasion of Iran and Kuwait and Putin’s invasions of Eastern Ukraine and Crimea.

Erdogan responded to the Gezi Park protests by scaling up military intervention in the Syrian civil war in 2013. The AKP’s losses in the municipal election in Istanbul and Ankara is the most serious threat to the Turkish President since the abortive summer 2016 military coup d’état attempt. This amplifies the risk of a Turkish military confrontation with Greece over Cyprus.

More by Matein: Please, please do not mess with King Dollar in 2019

Erdogan has also mismanaged his relations with the US, Germany, Egypt, Saudi Arabia and the UAE, all once staunch allies of the pro-West, secular Kemalist Turkish state. The xenophobic streak in Erdogan’s populist policies means that he will escalate a diplomatic crisis with Greece/Cyprus to boost his domestic power base or even unite rival factions in the AKP. Such a scenario will be naturally catastrophic for the Turkish economy and the Turkish lira. Turkey has never accepted the status quo in Cyprus, even if Erdogan is distressed by his own vassals in the northern rump state his predecessors created on the island. Isolated in the Arab world, ostracized by Washington and Berlin, Erdogan will align Turkey closer to Putin’s Russia, a paraiah regime in global politics. To quote Tallyrand on Napoleon’s judicial execution of the Duc d’Enghien, “it is worst than a tragedy – it is a blunder”. Sadly, the Turkish lira will pay the price of this blunder.