The central banks in many of the emerging market countries (Turkey, South Africa, India) have jacked up interest rates in an attempt to stop the slide in their currency’s value relative to the dollar. Idealistically, rate increases will stabilize the market and draw buyers back in.
The sell off by investors started last week after Chinese manufacturing reported a slowdown and has continued since then. Turkey made headlines last night after their midnight meeting concluded when they spiked up the emergency interest rate from 4.5% to 10%. While recovery seemed hopeful at first, the currency issue did not see much improved after a few hours.
First a little back story:
Turkey’s economy has been booming up until now. However, for approximately 20 years before Prime Minister Recep Tayyip Erdogan took office, inflation was very high in the country. Many Turks were generally unfaithful of their currency and would usually exchange/invest in the US Dollars or rare minerals like gold or silver with the intention of protecting themselves from inflation. In 2005, Erdogan put policies to stabilize inflation. The lira faced renomination, erasing six zeros essentially, followed by many inflation controlling policy. The Turkish people gained confidence once again with the lira and things were great with a fast growing economy and a below $2 exchange rate with the U.S. With the recent shift in the exchange rate once again, the Turkish people’s expectation for inflation may skyrocket, repeating the fresh-in-mind problem that many of them had suffered 20 or so years before. Expectation for inflation is a self-fulfilling prophecy. So in addition to this short-term problem, Turkey may fall into a much greater heap of troubles. Erdogan, in his third term, hopes to instill confidence to prevent a loss of trust in the lira. Erdogan has been publicly against an “interest rate lobby” despite the recent gusty spike, worried that it will choke Turkish growth. Once again I think this interest rate spike was necessary, but not sufficient. Uncertainty clouds the mind of many investors.
Paul McNamara, a large emerging-markets debt portfolio manager at GAM in London, showed a lot of uncertainty when sharing some his takeaways. He cites when the Euro was in trouble in 2012 and Mario Draghi reassured investors that the European central bank would do whatever it takes to keep the Euro.
“This is definitely not a Draghi moment that changes everything. It’s not 100% clear that this will work; stresses in Turkey are driven by fundamental factors. It takes Turkey in the right direction, but this could be grotesquely painful for the domestic economy. The chance of a run on Turkey is significantly lower, but it is still possible.”
Francesc Balcells, same job as McNamara but with more assets at Pacific Investment Management Co., shared much more insightful information saying:
“The rate hike makes more difficult for people to sell the lira, but this doesn’t mean necessarily people are coming in.”
“Let’s face it, the external environment is not generous with heavy borrowers with large current-account deficits. The Turkish central bank did the right thing but ultimately this was necessary but not sufficient.”
My recommendation is that Turkish government ensures faith in the Lira for its citizens who remember the hyper inflationary times not too long ago. The central bank should ensure compensate for inflation, protect its currency, just whatever it takes to prevent its citizens from investing in the US Dollar or gold. Hopefully, Turkey won’t fall back into another high inflation time. Their goal of improving their currency exchange rate was helped with the exchange rate spike, but the issue of inflation and an ever-growing deficit may still put-off potential investment from people like McNamara and Balcells. The vast economic improvement in Turkey after Ergodan did amazing things for a country that has, since it’s founding, had very strong ties to the West. Diversifying to Eastern markets has restored much of the confidence and prosperity by opening up new doors. The emerging markets deserve to recover sooner than later for the sake of improved standards of living around the world and a stable global market.