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Turkish Lira Hits Record Low, Spurring Expectations of Rate Rise -- 3rd Update

08/06/2020 | 01:14pm EST

By Caitlin Ostroff

The Turkish lira hit a record low against the dollar despite efforts by the country's central bank to curtail its fall.

It fell 2.5% Thursday, its biggest daily decline since March 2019, erasing 17.7% of its value for this year. At the currency's weakest, one dollar bought 7.3101 lira, putting it on track for its lowest-ever closing value. The previous intraday record low was one dollar buying 7.2692 lira, hit May 7.

Turkey has spent billions of dollars keeping the lira from falling after emerging-market currencies came under pressure in March, with investors pulling out of riskier markets as economies closed to contain the spread of coronavirus.

Some countries, including Brazil and Mexico, let their currencies weaken. But Turkey's central bank borrowed more foreign currency from domestic banks than it has in its coffers, selling that into the market and buying the lira. Goldman Sachs estimated the country had spent $65 billion this year managing its currency by the end of June.

"Clearly, the foreign-exchange intervention has failed. They are looking to conserve reserves," said Timothy Ash, senior sovereign strategist covering emerging markets at BlueBay Asset Management. "They're looking to see where the currency goes and where it stabilizes."

Turkey has tried to avoid a weaker lira due to concerns that it will drive up the cost of imports and stoke inflation, which stood at 11.76% year-over-year in July. Demand for imports has risen lately as President Recep Tayyip Erdo an's administration sought to offer cheap credit to homes and businesses to restart the economic recovery.

The increased demand for imports comes as the country is earning less dollars and euros because of waning tourism and a slump in exports. That has increased the funding gap between imports and exports, widening the current-account deficit and exacerbating the need for foreign currencies.

If the lira continues to drop, Turkey may be forced to raise interest rates again, Mr. Ash said.

He isn't alone in his projection. Analysts increasingly expect Turkey's central bank, which cut rates to 8.25% by May from 12% at the end of last year, will be forced to reverse course. Goldman Sachs expects rates will be raised to 10% by the end of the year, and 14% by the end of 2021.

The central bank, which is due to hold its next monetary policy meeting Aug. 20, said Thursday it was closely monitoring price developments in the market and would use "all available instruments to reduce the excessive volatility." It added that it would phase out liquidity facilities introduced during the pandemic, amid indications the economic recovery was gaining pace.

Boosting interest rates may deter foreign investors from unloading Turkish assets. Bond yields that are lower than inflation, combined with Turkey's efforts to bolster its currency, have prompted foreign investors to withdraw more than $4 billion from Turkish equities since the start of the year. They have also pulled out $7 billion from lira-denominated bonds.

Investors' diminishing appetite sent the yield on a Turkish five-year dollar-denominated bond up to 7.01% by Wednesday, from about 4.71% when it was issued in February.

In an effort to stem the lira's slide, authorities have made it more difficult for domestic lenders to provide lira to foreign banks. Limiting access to the lira makes it harder for foreign investors to bet the currency will weaken.

That sent the interest rate linked to borrowing Turkish lira in exchange for dollars in offshore markets as high as 1,000% Tuesday in annualized terms, according to analysts and investors, in yet another sign of how the currency's market has become dysfunctional.

On Thursday, Turkey's banking regulator partially eased access to the lira for foreign banks, so long as transactions are to buy lira-denominated assets or deposit lira in local banks.

The reduced access to the lira could put Turkish assets under pressure in other parts of the market as well. The cost of insuring against default on $10,000 of five-year Turkish dollar-denominated bonds using derivatives contracts called credit default swaps climbed to $589 a year Thursday, from $238 a year in February. Investors buy these swaps if they think the price for insuring against a default will rise further.

Fair value for the currency is about 7.5 lira to a dollar, based on estimates of Turkey's financing needs from its current account balance, according to the Institute for International Finance.

Elsewhere in currency markets, the ICE US Dollar Index, which measures the U.S. currency against a basket of others, fell 0.2% Thursday. In bond markets, the yield on 10-year U.S. Treasurys slid to 0.523%, from 0.541% Wednesday.

David Gauthier-Villars contributed to this article.

Write to Caitlin Ostroff at caitlin.ostroff@wsj.com


Stocks mentioned in the article
ChangeLast1st jan.
EURO / BRAZILIAN REAL (EUR/BRL) 2.24% 6.6542 Delayed Quote.2.58%
EURO / US DOLLAR (EUR/USD) -0.01% 1.2169 Delayed Quote.-0.41%
THE GOLDMAN SACHS GROUP, INC. 0.01% 289.39 Delayed Quote.9.73%
US DOLLAR / TURKISH LIRA (USD/TRY) -0.08% 7.4046 Delayed Quote.-0.20%
VILLARS HOLDING S.A. -1.34% 735 Delayed Quote.-5.16%
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