Low monetary credibility keeps strain on Turkish lira

Abstract

Significance The recovery from the record low of 4.93 on May 23 may reflect officials’ efforts to counteract President Recep Tayyip Erdogan’s disastrous interventions in Turkey’s economic policy debate. His vociferous opposition to a sharp and sustained increase in rates has sapped the inflation-fighting credibility of the Central Bank (TCMB). However, emerging market (EM) assets are also under strain from the rise in the dollar and US Treasury yields, fuelling concerns for a full-blown financial crisis given Turkey’s large external financing needs and relatively low foreign-exchange reserves. Impacts The euro’s fall versus the dollar due to fears of euro-area slowdown and disorderly Italian bond sell-off will put more strain on EM assets. Despite deteriorating market conditions, cumulative net inflows into EM bond and equity funds since January have so far remained strong. If OPEC and Russia raise oil output to cap prices, it could take some pressure off Turkey’s chronic current account deficit.