View of the Day: Turkish lira set to tumble

By Ulrich Leuchtmann

The Turkish lira faces the risk of a steep devaluation if the government presses ahead with an expansionary fiscal policy that makes a loan deal with the International Monetary Fund unlikely, says Ulrich Leuchtmann, currency strategist at Commerzbank.

“The government is not prepared to accept the fiscal cuts demanded by the IMF, particularly given that the country is in the middle of an election campaign,” he says. “This year’s budget plan is not worth the paper it is printed on. Spending remained high in January and tax revenues have collapsed.”

Mr Leuchtmann says the Turkish government is “playing with fire” by creating a double deficit (current account and budget deficit) that might interrupt crucial capital inflow.

He notes that Turkish foreign debt amounts to roughly 36 per cent of GDP, while the current account deficit is about 7 per cent of GDP – bad news in the current global environment of very high risk aversion.

“There is no doubt that a restrictive budget policy would be painful at a time of economic downturn,” he says. “But Turkey has only two alternatives to this scenario: either interest rates have to rise sharply, or it has to accept a dramatic lira depreciation. The former looks unlikely given last week’s surprise 150 basis point rate cut.

“Unless the government makes a fiscal policy U-turn after the elections in March, which would probably allow a speedy deal with the IMF, there seems no alternative to lira depreciation.”