The Turkish Manufacturing PMI, called The Istanbul Chamber of Industry Turkey PMI Manufacturing Index, in October fell to the level of 52.8 (hereinafter, if not stated otherwise, all data comes from Trading Economics). Just in August this year, this indicator reached an all-time high at 55.3 but then started to decline from there onwards. Indeed, starting from the beginning of this year, Turkish Manufacturing PMI demonstrated a significant increase in its value from 48.7 in January 2017 to 55.3 in August 2017. Such remarkable growth in expectations on the manufacturing sector of the economy was somewhat surprising because many experts predicted a sluggish economic performance following a 2016 coup d'état attempt in this country and the subsequent radical counter-measures, which affected more than 50,000 people (Turkey declares a state of emergency for three months). However, despite these measures, the Turkish economy became rather attractive for foreign investors seeking higher yield. Like the Manufacturing PMI indicator, business and consumer confidence indexes started to print weaker readings in H2 2017, but in the case of these indicators, this trend is even more apparent.
Coincident macroeconomic indicators have much more dangerous signals for the Turkish economy. CPI index almost doubled in the period after the coup attempt, and now stands at the level of 11.9% y/y in October 2017. The reasons for such remarkable growth are quite evident, because the Turkish lira decreased by more than 40% vs. the U.S. dollar in the same period, and falling national currency caused an acceleration of inflation. The direct engine of rising inflation is cheap credit, as part of the overall Turkish government attempts to boost economy via lending. For TCMB, which is the central bank of the Republic of Turkey, this is a real problem. Producer prices, standing at 17.28% y/y in October 2017, experienced even a bigger growth in 2.7 times since November 2016. The Turkish unemployment rate in August 2017 fell to 10.6% from 13.0% at the beginning of the year. Interest rates in Turkey are at the level of 8% and were kept unchanged by TCMB for the whole year. At its next meeting in mid-December TCMB can increase the interest rate, but in order to tame double-digit inflation, interest rate hikes should be substantial. Again, the main factors, which prevented TCMB from raising interest rates earlier, were purely political considerations, because high interest rates are not compatible with cheap credit – Erdogan’s most popular tool for securing social support and approval. Some analysts suggest that in order to curb rising inflation, the interest rate should be lifted to 15%. The Turkey GDP Annual Growth Rate in Q2 2017 amounted to 5.1%, which is pretty high. Still, we should understand that strong economic growth is almost a necessary political measure legitimizing Erdogan’s presidency and that the primacy of politics versus economics among Turkish policymakers causes a potentially dangerous situation. The long-term implications of such policy include a deceleration of growth, which is estimated to be at the level of just 3.5% in 2018 compared to the government projections of 5.5% for the same year.
The future USD/TRY exchange rate dynamics will very much depend on the outcome of Erdogan-TCMB confrontation. If political considerations prevail over the economic necessity of tightening monetary policy, we will probably see some short period of status quo. However, a lack of time required for improving the economic situation in the country will provoke an acceleration of depreciation of the Turkish lira. Vice versa, timely measures aimed at macroeconomic stabilization can lead to a recovery of TRY versus the U.S. dollar, in part due to the higher yield. I consider the first option as the main scenario for further exchange rate movement, since judging from the experience of other countries, it’s very difficult to remove political goals from central bank agenda, which will be forced to implement politically convenient measures, devastating for the national economy.
That is why we should be prepared for a decisive move higher in USD/TRY exchange rate. Now it’s trading around the level of 3.9500. Technically speaking, we can buy USD/TRY right now, with a three-month target around 4.3000, assuming an average 2.95% monthly volatility based on historical data.
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