Turkish lira headed for more volatility ahead of run-off election

Currency has been under severe pressure since President Erdogan started to adopt unorthodox economic monetary policies in 2018

Turkish banknotes. The country's currency fell to a near two-month low during trade on Monday. Bloomberg

The Turkish lira is headed for more volatility as early tallies in the country’s presidential election suggest that the first round of voting remains inconclusive.

A run-off looks likely within two weeks, a period analysts expect will be full of uncertainty and volatile trading for the country’s tightly controlled currency.

The lira traded near a two-month low earlier on Monday as state banks intervened to hold the exchange rate at about 19.65 to the dollar, Bloomberg reported, citing sources.

The currency closed at 19.58 against the greenback on Friday, about 4.5 per cent down since the beginning of this year.

“Political uncertainty is never good for investor sentiment and the next two weeks will be marked by uncertainty, low predictability and high volatility in Turkish assets,” said Ipek Ozkardeskaya, an analyst at Swissquote Bank.

“The USD-TRY is holding up so far but the [currency] pair advanced to the highest levels on record. The Central Bank of Turkey (CBT) is putting a lot of weight and money to keep the lira stable against the greenback.”

President Recep Tayyip Erdogan, who has ruled Turkey for two decades, is expected to head into a second round of voting on May 28 against joint opposition candidate Kemal Kilicdaroglu.

Both men have failed to achieve the 50 per cent of total votes required to win the Sunday’s elections.

With more than 98 per cent of the ballots counted, Mr Erdogan secured 49.3 per cent of the votes compared with Mr Kilicdaroglu's 45 per cent.

While it is still possible that Mr Erdogan could declare victory, a run-off election appears to be the most probable scenario.

Turkish stocks also plunged on Monday, with the benchmark index dropping more than 6 per cent, triggering a circuit breaker that halted trading.

Turkey’s 10-year yield also jumped more than 8 per cent earlier on Monday.

“The major risk is the lira,” Ms Ozkardeskaya said. “Will the CBT keep its FX [foreign exchange] strategy unchanged and defend the lira? Will it be able to counter an eventually increased selling pressure on the lira? If no, what happens to the lira?

“A sudden jump in USD-TRY is a possibility, a severe devaluation of the lira could inject further volatility to Turkish stock and bond markets.”

The Turkish currency has been under severe pressure since Mr Erdogan began to enforce unorthodox economic monetary policies in 2018.

Turkey aggressively cut interest rates to boost growth even as inflation surged. Market interventions by the central bank have totalled nearly $177 billion over the past 16 months, according to an estimate by Bloomberg.

“The Turkish currency has depreciated dramatically over recent years due to events such as clear indications that the current president of Turkey has influenced central bank policy along with a public narrative of the need for low interest rates,” Jameel Ahmad, chief analyst at CompareBroker.io, said in a research note on Monday.

“This has contributed to ongoing economic challenges for Turkey.”

Up until the devastating earthquakes in February, Turkey's economy had been performing well.

The country’s gross domestic product posted the third-highest growth among G20 countries in 2022, rising 5.6 per cent, slightly behind India and Saudi Arabia, the Organisation for Economic Co-operation and Development reported last month.

This followed an 11.4 per cent growth in 2021.

However, the earthquakes, which also struck Syria, left Turkey's economy and society reeling.

The damage caused by the quakes and the subsequent tremors is estimated to exceed $100 billion, according to a UN report.

Meanwhile, reconstruction is expected to require external financing of as much as 12 per cent of GDP, although a considerable portion of this could come from grants rather than debt, the report said.

In April, S&P Global Ratings revised its outlook for Turkey to negative, from stable, citing an increase in broader public sector risks and higher reconstruction costs after the earthquakes.

Turkey's long and short-term sovereign credit ratings were affirmed at “B”, which is two levels below investment grade on S&P's scale, the rating agency said at the time.

The Turkish economy and the reconstruction of quake-affected areas have been the two contentious issues in the run up to the polls.

Julius Baer, which maintained its “sell/speculative” rating for Turkish sovereign bonds while staying “underweight” for equities”, on Monday said the economic backdrop remained challenging.

“We expect a lot of volatility in Turkish assets, in particular the currency, ahead of the second round,” Julius Baer analysts Eirini Tsekeridou and Nenad Dinic said.

“A change in Turkey’s political leadership and a return to more orthodox economic policies would lead us to reassess our view, but the final outcome will not be known for another two weeks.”

While Mr Erdogan is committed to pursuing his unorthodox monetary policies, Mr Kilicdaroglu’s has promised to reverse them, put in place measures to ensure the central bank is autonomous and adopt an interest rate policy that reflect the country’s economic situation.

Turkish stocks and bonds held by foreign investors stood at less than $24 billion as of the end last week, which is down from about $152 billion a decade ago, according to data compiled by Bloomberg.

“Even if Erdogan was to hypothetically lose the elections, the outlook is not necessarily that the lira will strengthen immediately. This is because of the risk of protests and other potential civil events that could present a picture of Turkey going through further uncertainty over the near term,” Mr Ahmad of CompareBroker.io said.

“I would expect there to be a likelihood that investors will prefer to stay well clear of Turkish assets until the dust clearly settles from the 2023 Turkish presidential elections. This could take weeks.”