Currency Wars: Turkish edition

Monday, August 13th, 2018

The Turkish Lira has been in the spotlight over the last few days as escalating tensions with the US have led to large depreciation of its currency.

According to The Economist, the US Treasury imposed an asset freeze on two senior Turkish officials over the detention of an American pastor. Turkey responded in kind by putting sanctions on two members of Donald Trump’s cabinet. Then on August 10th, Donald Trump tweeted he would double tariffs on Turkish steel and aluminium, resulting in the lira falling to the lowest levels it has seen in a decade.

Investors have been spooked not just by the tensions US but also by the deteriorating economic outlook of the Turkish economy. From Bloomberg Quint:

For much of Erdogan’s almost 16 years in office, Turkey enjoyed China-like levels of growth. But unlike China, an exporting powerhouse with a current-account surplus, Turkey runs one of the world’s largest deficits because its expansion was fueled by foreign debt. That all seemed fine when the world’s central banks were pumping cash into markets to help pull economies out of a crisis. But not anymore, as global interest rates rise and investors, less enamored with emerging markets, pull funds back to developed economies. Turkey buried much of the tens of billions it received from abroad in construction projects and shopping malls, which pushed up short-term growth. But that did little to improve productivity, or output per worker, the main source of long-term economic growth and higher living standards.

Inflation is above 15 percent, more than triple the central bank’s target. Yields on some government-issued debt are at record highs, and the Turkish lira is melting down. All that not only hurts consumer sentiment and wallets, it pushes corporate balance sheets closer to the abyss. Companies that borrowed heavily in foreign currencies now face a growing burden due to the tanking lira and rising borrowing costs. Instead of reducing government debt and deferring to the central bank to cool the economy with higher interest rates, Erdogan wants to keep the party going with low interest rates to finance even more construction.


This is a dangerous cocktail and could have spillover effects on other currencies and markets. We can already see from the chart above that most emerging market currencies have depreciated against the dollar from the start of the year as trade tensions have escalated globally.

India too has not been spared, with the Rupee hitting 69 today. Even though currently our macros are stable and we have sufficient FX reserves, our economy is faced with an expanding current account deficit, rising inflation and a banking sector saddled with NPAs.

How does currency depreciation feed into equity market? Ben Inker at GMO had a great chart last month on the correlation between emerging market currencies and their equity markets:

In his own words:

Emerging assets had a lousy quarter of the classic variety. In the face of falling currencies, local stock markets moved lower as well. This is par for the course for emerging equities, even if it is not obvious that the fundamentals support such a correlation. While the currency fall predicts nothing about future returns for emerging assets, the stock market declines do suggest there may be some more short-term pain to come, given the historical power of momentum to predict emerging returns. On the other hand, both emerging stocks and currencies are cheaper than they were three months ago, and historically cheaper valuation has been a plus in both the short and long term. Exhibit 12 shows the margin of superiority for our favorite asset relative to our next favorite asset through time on our asset class forecasts. Emerging market value stocks are the best asset we can find, by a margin that is just off of the largest we have ever seen.


About the author

Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.

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Quarterly Equity Valuations: August 2018

Private vs. Public