Turkish Lira May Have Room To Run As Emerging Markets FX Soars

by Geoffrey Smith

Emerging market currencies have had a great start to the year. The slowdown in the world economy has forced the U.S. Federal Reserve to interest rate hikes and the European Central Bank (ECB) to dial back plans for its first such move.

The relief in emerging markets has been evident: the Russian ruble . But one of the big plays in EMFX has been left behind—and unjustly so, in the eyes of some.

The Turkish lira has only eked out a 0.3% gain against the dollar year-to-date, despite support from sky-high interest rates, a rapidly-improving balance of payments and encouraging—if still slow—signs of progress in tackling high corporate debt levels. Clearly, memories of last year’s rout, when the lira fell 45% in the six months to August after President Recep Tayyip Erdogan pressured the central bank not to raise interest rates, are still fresh and painful. Trust in a central bank and a currency takes only days to destroy, but months or even years to rebuild.

But last year’s collapse, while clearly induced by domestic policy, came against the background of rising dollar interest rates and expectations that the ECB, too, would move slowly towards raising its key rate. That outlook has now changed, and fears that big European banks such as Unicredit (MI:CRDI) (MI:BBVA ) would pull resources from their local subsidiaries and trigger a credit crunch have proved largely unfounded.

“Right now, we like the lira more than the ruble or the rand,” said Charles Robertson, head of research at emerging market specialist Renaissance Capital. He argued that the lack of a rebound from last year has left the lira 20% below its long-term average rate.

Additionally, Turkey’s official Inflation is still running at an annual rate of 20.35%.

ING economist Muhammet Mercan reckons the central bank won’t cut until June at the earliest, when basis effects will allow a “convincing” drop in the year-on-year inflation rate.

Clearly there are still risks ahead: The government’s announcement last week that it is looking at the possibility of planned withdrawal of U.S. forces from northern Syria creates scope for various mishaps: not only is Erdogan vying for influence in the region with Iran, Saudi Arabia and Russia, but he risks a fresh spat with the U.S. over the Syrian Kurds, whom he suspects of aiding Kurdish rebels in Turkey.

The risk of political interference in economic policy also remains: Erdogan’s party faces mayoral and municipal elections across the country at the end of March. But for now the signs are that the government thinks it has more to lose than to gain from renewing its assault on the central bank.

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For foreign investors at least, sentiment towards Turkey is improving. The Finance Ministry was able to sell bonds in both dollars and euros without problems in January. If the government can convince its own people, too, that it won’t repeat last year’s mistakes, the lira’s rebound should have further to go.

Written By: Investing.com