Low liquidity

The gross foreign exchange reserves of Turkey are under continuous pressure even if they have increased compared to their low level recorded in September 2018 (cf. graph 1). In relative terms, they cover more than 3 months of imports, an adequate level on paper. The sharp import contraction in Q3 2018 partly explained this relatively favourable level as well as the current account surplus registered in Q3 and Q4 2018 after years in deficit (exports increased, but to a lesser extent). In Q1 2019, the current account balance moved back into deficit. Still, liquidity remains weak, as highlighted by Credendo’s short-term political risk classification in category 4/7. Other factors explaining this classification are the very high short-term external debt (at USD 120.6 bn in April 2019, according to the central bank of Turkey) and the fact that Turkey still has access to the international capital market (albeit at higher prices than before August 2018).

Foreign investors’ confidence is important

In this context, it is very important for Turkey to continue to attract enough capital inflows in order to avoid being in the same situation as in August 2018, when the lira depreciated sharply and gross foreign exchange reserves were under severe pressure. Domestic policies as well as global financial conditions – influenced among other things by the US monetary policy, evolution of trade tensions and geopolitical risks – are shaping foreign investors’ risk perception.

Regarding policies – that are under Turkey’s control –, some recent developments might trigger a spike in foreign investors’ risk aversion. Following the recent dismissal of the central bank governor by a presidential decree, it remains to be seen whether his successor will be able to gain the market confidence and pursue an independent monetary policy. Drilling in Northern Cyprus – a country recognised by Turkey but not by the EU – is also likely to alienate support from the EU. On the positive side, the EU response has been measured so far. Indeed, the EU suspended the envisaged EU-Turkey comprehensive air transport agreement, reduced the pre-accession assistance to Turkey for 2020 and asked the EIB to review its lending activity in Turkey. Last but not least, the delivery of surface-to-air missile system from Russia – that started on 12 July – led the US to suspend the delivery of F-35 jets to the NATO member and might be punished by US sanctions. The adoption of comprehensive sanctions by the US could have a devastating impact on investors’ confidence and thus lead to renewed pressure on the exchange rate and gross foreign exchange reserves.

Analyst: Pascaline della Faille - P.dellaFaille@credendo.com