Turkey: Still a growth star
This post is a guest contribution by Tevfik Aksoy & James Lord of Morgan Stanley.
Rate Cut Threat Still on the Table
The main reason for expecting further short-term weakness in TRY is the threat of a further rate cut from the CBT in the coming months. The CBT made it clear in its latest Inflation Report that the future policy mix will continue to involve low interest rates combined with higher reserve requirement ratios (RRR). This dual approach is designed to help meet multiple policy objectives, including a weaker currency, slowing credit growth and a narrower current account deficit. Accordingly, we expect a further cut in the policy rate at the next meeting in February (see New Approach to Monetary Policy: Will Creativity Be Rewarded? January 26, 2011, by Tevfik Aksoy). What’s more, even if the CBT does not cut, we think the market will trade poorly ahead of the meeting, given the risk of a further reduction in the policy rate.
Further increases in the RRR are also likely to occur, to help offset the stimulus that a lower policy rate would create. We have to admit that the recent hike in RRR encouraged us in the sense that the notable extraction of liquidity from the system (TRY 9.8 billion), which will become effective as of February 18, could actually be considered as tightening despite the cut in policy rate. Nevertheless, the market is likely to focus more on the signal from the policy rate. And as long as there are risks that it could be cut further, TRY is likely to suffer. We think that USD/TRY could test 1.62 in the coming weeks, assuming a stable EUR/USD.
Watching for a Moderation in Credit Growth
The CBT’s new policy mix will address the ongoing rapid growth in loans, especially that of consumers, which has been expanding at a rate of around 40%Y and heading towards 50+%. Until inflation bottoms out and starts rising to a degree that causes a deterioration in inflation expectations and widens the credibility gap for the CBT to act, we think it is very probable that the policy rate will be kept low while successive RRR hikes are likely. In the past, we used to concentrate almost solely on inflation and the reasons behind it, but paid little attention to credit growth as interest rates were relatively high and the penetration rate was low. However, we will now be monitoring changes in the growth rate as well as the overall tendency in consumer loans to judge or predict if the CBT will make further moves.
Given the importance of credit growth to the future direction of monetary policy, any sign that credit growth is starting to moderate could be taken by the market as a sign that the CBT may think about shifting its stance. This shift in stance is required, we believe, to turn the TRY around. As such, we would take signs of moderating credit growth as a bullish signal for TRY.
Turkey Still a Regional Growth Star
Turkey’s strong economic fundamentals remain intact. Growth is strong, and we expect it to come in at around 4.7% this year following an estimated 7.4% rate in 2010. Fiscal policy is prudent, while upgrades from rating agencies look likely following the June elections. Accordingly, there are several fundamental reasons to expect TRY to appreciate. The ongoing widening in the current account does pose a risk to the TRY, particularly if external shocks materialise. The widening in the C/A deficit has been quite persistent, and deterioration in the non-energy component particularly noteworthy.
However, the financing of the deficit looks reasonably comfortable for now, given the strength of external borrowing from the local banking and corporate sector.
Gradual Recovery from 2Q?
Given the strong fundamentals, we see the monetary policy stance as the key variable to consider in anticipating a recovery in TRY. We do not think that the CBT will be able to sustain consistent policy rate cuts through the year. Indeed, the lower the policy rate goes, the greater the risk this poses to the currency, in our view. Forecasting monetary policy is fraught with uncertainty, and thus timing the recovery in TRY will be similarly difficult. However, we have pencilled in 100bp in policy rate hikes for later in the year and, as the market anticipates this, TRY should begin to recover. We are tentatively pencilling in a recovery in TRY in 2Q, though this will be assessed on an ongoing basis as developments take their course. General elections are scheduled for June, but we do not see this as a headwind for a recovery during 2Q. Indeed, political stability is likely to be maintained, and fiscal policy should stay prudent.
Stretched Momentum Suggests Tactical Opportunities
Speculative positioning in TRY is now low, and given the sharpness and size of the recent depreciation, we believe that there will be tactical opportunities to buy TRY, but only on a very short-term basis. Momentum is stretched and suggests that TRY is oversold on a technical basis, versus both the major G10 currencies and many EM currencies. Because of this, we could see temporary periods of TRY strength. Ultimately, we believe that this strength will be self-correcting, as the CBT would probably be more inclined to cut rates as the TRY appreciated, and thus place downward pressure on the currency again. We would fade any moves below the mid-January low of 1.53 in USD/TRY.
Risks to Our View
One of the features of the recent sell-off in TRY has been the lack of USD selling from the retail and corporate sector in Turkey. Typically, locals swap foreign exchange deposits for TRY as the TRY weakens, thus taking advantage of better levels. However, on this occasion, and reflecting the monetary policy uncertainty, locals have been less active. USD deposits have been reduced by around US$10 billion since the TRY started depreciating, reversing only about half of the accumulation in USD deposits since June, despite USD/TRY moving back to June levels.
Should USD/TRY head higher too quickly, it is possible that locals decrease their USD selling activity even more, thus increasing the downside risks to TRY. This is short-term downside risk for TRY.
On the flipside, a rapid deterioration in inflation expectations could cause the CBT to reverse course quicker than most in the market currently assume. This would provide some stability for the TRY.
Source: Tevfik Aksoy & James Lord of Morgan Stanley, February 1, 2011.
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