As Turkey’s government is working to reverse years of unorthodox economic policy, the country’s embattled currency is now seeing FX carry-trade investors returning, according to Al-Monitor based on a report by the global investment bank Goldman Sachs.
A carry-trade is the return an investor gets for holding, or carrying, a low-interest-rate currency and then converting the borrowed amount into another currency with a higher rate of return.
“The recent increase in policy rates suggests that deposit rates are likely to increase further, and while implementation risks clearly remain, the recent articulation and support of a positive real rate strategy — in sharp contrast to previous years — suggest that it may be possible to beat the FX depreciation reflected in forward pricing again, implying that the Lira carry trade is back,” Goldman analysts wrote in a report dated Sept. 27.
Last week, Turkish interest rates rose to 30% from 25%. Goldman economists forecast that a nominal rate of around 40% will bring Turkey’s real rates into positive territory. The real interest rate is the nominal interest rate (30%) minus the rate of inflation, which can be expected or annual.
“With this more front-loaded and forceful rate adjustment, near-term pressures on the currency have eased, and that should allow the Lira to continue to outperform near-dated forwards during this period,” Goldman Sachs analysts added.
Skyrocketing inflation and the Turkish lira’s swift depreciation forced Turkish President Recep Tayyip Erdogan to abandon his unconventional economic policy — of keeping interest rates low, despite high inflation — after his reelection in May.
He appointed mainstream economists to run the country’s economy, naming ex-Merrill Lynch economist Mehmet Simsek as finance minister and former US banking executive Gaye Erkan as the country’s first female central bank governor.
Both Simsek and Erkan pledged to return to conventional ground in the economy and advocate for tighter monetary policies.
Turkey’s Central Bank has raised the country’s interest rates from 8.5% to 30% in successive hikes since June in a bid to rein in the country’s high inflation amid an acute cost-of-living crisis. Turkey’s annual inflation rate hit nearly 60% in August, according to official data. Under Erdogan’s “growth at any cost” economic policy prior to the elections, the country’s annual inflation peaked to a 24-year high of 85.5% in October last year before relatively easing in ensuing months.
In its report, Goldman Sachs also heralded “a remarkable” rise of Turkish equities this year — around 50% — following the interest rate hikes, offering one of the strongest equity returns in the world. But it noted that the gains relatively have been less, as the Turkish lira has depreciated by 46% this year.
Simsek, for his part, has been seeking to regain the confidence of international markets to lure foreign funds to alleviate the country’s acute foreign currency crunch. The minister met with investors in New York on Sept. 19 and will be meeting banks in London on Oct. 3-4, Reuters reported on Thursday.
Turkey’s net foreign reserves fell below zero in May for the first time since 2002 due to what government critics describe as a scheme that depleted foreign reserves through backdoor means to prevent a currency shock before the May elections.
In August, Simsek said the central bank’s net foreign reserves exceeded $15.7 billion, increasing by more than $20 billion.
The medium-term economic program that the government unveiled in early September reiterated the Turkish government’s resolve for tighter and rational monetary policies.
In another sign of strengthening foreign confidence, the World Bank on Sept. 7 decided to increase its exposure to Turkey up to $35 billion over the next three years.
Simsek hailed the decision, saying it “was a further endorsement” of the government’s medium-term economic program.