TRY set to weaken further on capital outflows – Danske Bank

Research Team at Danske Bank, notes that recently, Turkey imposed a three-month state of emergency, which came into effect as of 01:00 local time on Thursday.

Key Quotes

“This follows events in recent days, with around 60,000, largely government officials, either suspended or removed from their posts. The state of emergency allows President Erdogan to issue decrees that take immediate effect and are not subject to review by the constitutional court.

Meanwhile, on Wednesday S&P lowered its foreign currency rating on Turkey to ‘BB’, from ‘BB+’ with a negative outlook. The rating agency also lowered the country’s local currency rating to ‘BB+’, from ‘BBB-’ with a negative outlook. In its rationale for the rating downgrades, S&P stated that following the attempted coup on 15 July, Turkey’s political landscape has fragmented further, which will undermine the country’s investment environment, growth and capital inflows. Hence, the risks to Turkey’s ability to roll over its external debt has increased.

The Turkish lira (TRY) has weakened around 6% since the attempted coup last Friday. The state of emergency and the rating downgrade add to the risks for the TRY. Turkey still runs a relatively large current account deficit of around 4% of GDP and hence is in need of capital inflows.

Concerns about whether economic policies will change and the reform process will derail could weigh on short-term portfolio inflows, which may also be affected by the risks of further rating downgrades. Foreigners own around 30% of Turkey’s government bonds, which reflects that Turkey is part of the JP Morgan GBI-EM-Global Diversified Bond Index. While positioning in Turkey has been reduced compared with early 2013, emerging market investors may shift further out of Turkey and into, for example, Brazil given its recent increased political predictability.

In light of the changed political landscape in Turkey, we have lifted our USD/TRY forecasts to 3.12 in 1M (from 2.95), 3.20 in 3M (2.98), 3.25 in 6M (3.03) and 3.35 in 12M (3.05). Near term, we expect lingering political uncertainty to weigh on capital inflows into Turkey and thereby on TRY.

Medium term, we expect Turkey’s relatively solid economic growth to provide some support for the TRY. In this regard, we note the experience in other emerging market countries, e.g. Thailand, which has had relative currency stability in periods of state of emergency. We do not believe the current political chaos in Turkey will have any broader impact on global risk appetite and the performance of risky assets.”