The Lira situation will only get worse before it gets any better

Turkish Lira has plummeted 11% today, after briefly recovering from a 15% loss against the dollar. This marks a YTD loss to over 40%, blowing out the Argentine Peso, the second worst FOREX performer of -16%. As we have previously discussed a few times in our quarterly reports, the downfall of the Lira was very much a matter of time, not a matter of probabilities, but we are still surprised by the magnitude of the move in such a short timeframe. Below are a few key takeaways to summarize the Lira weakness thesis:

- depleting foreign reserves, negative net reserves if taking consideration of derivative products
- High external dollar denominated debt
- Corporate debt remains a majority of total foreign debt, stress on solvency
- Persistent high inflation and unwillingness to tame with tightening policy
- Instability causes foreign capital flight and to a less extent domestic dollarization
- Grim economic outlook as COVID impact lingers

To put it in simple words, the depreciation of Lira could mean that the country is now 40% more in debt than at the beginning of the year, and their ability to repay is now 40% weaker. Combine this solvency stress at both the corporate level and the national level with a renewed capital flight, further stagnating the economy, could easily result in a accelerating spiral downward that ends in a national default. Most recent Turkey 5 year CDS printed 442.05, a 7.4% implied probability of default with a underlying 40% recovering rate assumption.

Despite a real crisis emerging, President Erdogan’s stance did nothing to comfort the market, but exacerbated the freefall, as a reiteration for lower interest rates to boost economic growth and job creation instead of supporting the Lira with tight monetary policy provided more fuel for the situation. The “independent” CBRT added more salt on injury with comment of “under certain conditions, the central bank may only intervene in excessive volatility without aiming any permanent direction”, implying today’s move was not excessive enough to merit intervention.

With no positive catalyst in sight, the Lira situation will only get worse before it gets any better.

- Charles