Lira plunges more than 7% as Turkey edges towards free market

Turkish lira: Turkey's lira plunged 7.6 per cent to a record low on Wednesday in its biggest selloff since the historic 2021 crash, and traders called it a "strong signal" that Ankara is moving away from state controls toward a freely traded currency. The lira has come under increasing pressure since President Tayyip Erdogan was re-elected on May 28. It was trading at 23.2300 against the dollar at 1739 GMT, after touching a record low of 23.2620, bringing losses this year to nearly 20 per cent.

Under Erdogan's unorthodox programme, authorities have taken a hands-on role in foreign exchange markets, using up tens of billions of dollars of reserves this year alone to hold the lira steady. The central bank's net forex reserves hit an all-time low of negative $4.4 billion last month as demand surged through the elections. But Erdogan signaled a U-turn at the weekend when he named Mehmet Simsek, a former deputy prime minister who is well regarded by foreign investors, as finance minister. Simsek later said economic policy needed to return to "rational" ground and on Wednesday said there were "no quick fixes" for policy.

Four traders said the decline in the central bank's forex and gold reserves had stopped as of last week, and could begin to recover, along with signs of the change in forex policies. Though many regulations need to be changed, "the destination is becoming clearer every day: We are going towards the lira's value being determined by market conditions," one trader said.

Erodgan is considering appointing Hafize Gaye Erkan, a U.S.-based senior finance executive, as central bank governor, Reuters reported on Monday. She would succeed Sahap Kavcioglu, who has spearheaded Erdogan's rate-slashing drive since 2021. Given the heavy selloff, some analysts said the central bank might hold an emergency meeting to hike interest rates. An emergency hike "is very possible (and) could stabilise markets in the short-term," said Ulricht Leuchtmann, head of FX research at Commerzbank.

"It smells like the beginning of a lira crisis," he added. "This is what happens when you get an exponential move - for a long time you think nothing happens, and then all for a sudden all hell breaks lose." The bank's next policy meeting is scheduled for June 22. Some analysts expect the lira to weaken towards a range of 25-28 against the dollar. Another trader said the currency was nearing levels at which it "will not need to be defended with reserves," adding that sharp intraday losses could continue for some time.

RETURN TO ORTHODOXY

Under pressure from Erdogan, a self-described "enemy" of interest rates, the central bank slashed its policy rate to 8.5 per cent from 19 per cent in 2021 to boost growth and investment. But it sparked a historic lira crisis in December of 2021 and sent inflation to a 24-year high above 85 per cent last year. The return of Simsek, who was finance minister and deputy prime minister in 2009-2018, signalled a move away from the unorthodox rate cuts despite high inflation that have sparked a more than 80 per cent erosion in the lira's value in five years.

Erkan, the candidate to run the central bank, met with Simsek in Ankara on Monday and was set to later meet Erdogan, Reuters reported. A former co-CEO at First Republic Bank, Erkan would be the country's fifth central bank chief in four years, after Erdogan fired previous governors as part of frequent policy pivots. Turkish authorities are now hoping foreign investors will return after a years-long exodus, but market watchers cautioned that Erdogan turned to conventional policies in the past only to change his mind shortly after.

Turkey's sovereign dollar-denominated bonds gave away early gains to trade slightly negative on the day. The premium demanded by investors to hold the country's hard-currency bonds over safe-haven U.S. Treasuries widened again to 472 bps after tightening nearly 200 bps in the second half of May, data from JPMorgan showed. Five-year credit default swaps dipped to 485 from Tuesday's close of 491.

The main BIST-100 stock index has rallied in nine of the last 10 trading days, and closed 3.2 per cent higher on Wednesday. The banking index rose some 2.39 per cent. "The process of getting Turkey onto a sustainable path is going to be turbulent and likely involves substantial devaluation and higher yields," said Paul McNamara, director of emerging market debt at asset manager GAM. "We think fair value for the lira is probably 15 per cent or so lower, but containing a devaluation without substantial external support is going to be a desperately difficult task," he said before Wednesday's decline.

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