Turklish Lira crisis and its impact on Indian Rupee

Monday,   13-Aug-2018   05:37 PM (IST)

The economic situation in Turkey has been a powder keg for months and it’s finally found a spark. Turkish President Recep Tayyip Erdogan’s already questionable credibility got a further blow in recent months as he appointed his son-in-law as the country’s finance minister and espoused his belief that lower interest rates were needed to fight inflation. At first glance, Turkey’s economy appears to be doing alright. The country’s GDP grew by 7% in 2017 and appears on track to match that growth this year. The issue, however, is that inflation is running rampant at about 16%. With price pressures running hot, the Central Bank of the Republic of Turkey (CBRT) was expected to hike interest rates from their current 17.75% level in last month’s meeting. In defiance of investors’ and economists’ expectations, the CBRT instead held interest rates steady, sparking a selloff in the Turkish lira (TRY).

That selloff turned into a rout last week after the US threatened (and has now instituted) punishing sanctions on two senior Turkish ministers, as well as Friday morning’s announcement of steep tariffs on metals. Trump said he had authorized higher tariffs on imports from Turkey, imposing duties of 20% on aluminium and 50% on steel. Those duties are double the level that Trump imposed in March on steel and aluminium imports from a range of countries.

While Turkey and the United States are at odds over a host of issues, the most pressing disagreement has been over the detention of U.S. citizens in Turkey, notably Christian pastor Andrew Brunson who is on trial on terrorism charges. A delegation of Turkish officials held talks with counterparts in Washington last week but there was no breakthrough. Turkey’s currency has fallen by a staggering 83% year-to-date against the US dollar with 16% fall on Friday and over 13% intra-day fall today. Turkish lira hit a record low of 7.21 today before recovering to 6.92.

Reminiscent of the European debt crisis of 2010 and 2011, investors are now turning their attention to the next domino to fall. According to the ECB, there are three European banks (Banco Bilboa Vizcaya Argentaria (BBVA), UniCredit and BNP Paribas) with heavy exposure to Turkish debt and many of their loans are unhedged. All of them are selling off sharply as a result. According to data from the Bank of International Settlements, Spanish lenders are the most exposed followed by Italian and French banks. If Turkey’s economy crumbles more migrants could be headed to the EU, making Turkey a political and economic crisis for the region. The EUR sank to its lowest against the USD in more than a year on Friday. The lira sell-off has deepened concern particularly about whether over-indebted companies will be able to pay back loans taken out in euros and dollars after years of overseas borrowing to fund a construction boom under Erdogan.

Plunging Turkish Lira sparked broad risk aversion and put a damper in risk appetite across global markets, with European stock markets selling off by 1-2%, US stocks trading lower, and EUR/USD hitting a 1-year low. The risk-off sentiment spread into other markets with the South African Rand plunging more than 10% early Monday to trade at a two-year low of 15.32 per dollar. The Argentina Peso and Russian Ruble were also amongst the biggest decliners in Emerging Market currencies. Equity markets across Asia were also smashed, with the Nikkei, KOSPI, Shanghai and Hong Kong indices all falling more than 1.6%.

Impact on Indian Rupee

In line with global risk aversion, Indian rupee too witnessed a sell-off. Rupee has shaved-off over Rs.1.00 from its Friday’s close of 68.8250 to touch an all-time low of 69.93 in today’s trade. Rupee had earlier hit an all-time low of 69.13 on 21^st July 2018.

In addition to the ongoing situation in Turkey, Indian rupee has been under pressure since the beginning of this fiscal year as it grapples with domestic problems of its own. Higher crude prices coupled with ballooning current account deficit, discontinuance of Letter of Undertaking (LoUs) for trade credit for imports, uncertainties relating to inflation and fiscal slippage etc have played spoilsport for rupee. Globally, US-China trade war, depreciation of Chinese yuan, strong US data and continuous hawkish stand from Fed have also put tremendous pressure on EM currencies including rupee.

Looking forward, from Turkey’s side, Turkey's Central Bank has announced a series of measures today to support the Turkish Lira which includes –raising foreign exchange deposit limits for lira transactions of lenders from €7.2 billion to €20 billion ; lowering Turkish lira reserve requirement ratios by 250 basis points for all maturity brackets, and reserve requirement ratios for non-core FX liabilities by 400 basis points for up to three-year maturities. The Central Bank has also vowed to provide "all the liquidity" needed by banks. Investors need to see many more serious economic and diplomatic measures to prevent things getting completely out of control.

In addition to the crisis in Turkey, the near-term focus of global FX market now moves squarely to politics rather than economics as the emerging EM crisis, the slow motion boil of the trade war and the side skirmishes between Russia and US and Canada and Saudi Arabia could all contribute to a huge rise in volatility.

On the domestic front, RBI was seen protecting rupee at every fall to 69 and beyond. However, with the current global geo-political and domestic macro-economic situation, intervention by RBI is unlikely to yield any meaningful result. RBI has already seen a fall in its reserves to the tune of $23.38 billion from its record high of $426.08 billion hit as of the week ended April 13 to $402.70 billion as of the week ended August 3 in this fiscal year. RBI is yet to act on the recommendation of Parliamentary Standing Committee on Commerce made on 6^th August 2018 to restore the facility of LoUs at the earliest with proper safeguards in order to increase the availability of credit for traders. If this facility is restored it could take-off some pressure from rupee. Moreover, RBI can also opt for issuing foreign currency NRI bonds in the range of $30 - $35 billion like it did in 2013 to stem rupee’s fall and prop up the reserves.

With emotions ruling the market and global volatility in the stratosphere, there’s no telling how far the currency could fall in the coming days and weeks in absence of any concentrated measures from RBI and given the global scenario. However, on technical grounds rupee may find support in the range of 70.50– 70.75. If RBI comes out with some significant measures, then rupee may strengthen to 68.20-67.80 range.