Politics and economics: The rupee’s Turkish worries

Bad economic management and crippling US tariffs have battered the lira, and Turkey’s currency crisis has triggered fresh selling across emerging markets. The already sliding rupee has reacted sharply.

Written by Anil Sasi | New Delhi | Published: August 15, 2018 2:03:37 am
American pastor Andrew Brunson remains in detention in Turkey. (Photo: Reuters)

On Tuesday, the rupee breached the 70-mark for the first time against the US dollar, hitting a new low of 70.08 in intra-day trading. A day earlier, the Indian currency had recorded its biggest intra-day fall in five years, hitting 69.93 against the greenback, amid rising concern that the precipitous slide of the Turkish lira could spark fresh turbulence in global currency markets.

The falling lira

The lira has been in free fall following political and economic problems in Turkey, combined with fresh trouble on the external front. President Donald Trump’s doubling of US import tariffs on Turkish steel and aluminium has further strained the already wobbly relations between the NATO allies.

The primary reason for the ongoing rout in the lira, though, is poor economic management by the government of President Recep Tayyip Erdogan. The Turkish economy is overheating due to soaring inflation, which reached an annual rate of nearly 16% in July, mounting levels of foreign debt, and a very high current account deficit. Both the Turkish government and central bank are facing a serious loss of credibility. There are signs of a massive bubble in the construction sector, further threatening the country’s already fragile banking system.

Even before Trump’s tariff hit sparked the current crisis last week, the lira had been the world’s worst performing currency, having slid by almost 50% against the dollar in the past one year. After the US move, the lira has fallen by a fifth against the dollar during the past week alone.

Political trigger

Behind the trade dispute is a standoff over Andrew Brunson, an American Christian pastor who has been detained in Turkey since October 2016 on charges of terrorism, espionage, and of helping plan the failed coup d’état against Erdogan. Turkey is also holding an American NASA scientist, and three Turkish nationals working for US consulates in the country. The countries had appeared to come close to an agreement last month, but the deal collapsed at the final stage, infuriating Trump who on July 26 threatened “large sanctions” if Brunson was not released immediately. The tariffs and the crash of the lira followed, and the two countries were plunged into what is being described as the worst bilateral crisis since the US arms embargo on Turkey following its invasion of Cyprus in 1974.

By The New York Times, Source: FactSet

Erdogan has remained defiant amidst the currency crisis, and threatened Tuesday to boycott all American-made electronic products. The lira pulled back from a record low it hit a day earlier, helped by the Turkish central bank’s new liquidity measures.

Reports from Ankara, though, suggested Turkey’s options were shrinking. According to estimates by the International Monetary Fund, Turkey has the “least adequate level of reserves of the major emerging market economies, which makes it particularly vulnerable to speculative attacks”, The Guardian reported. There are concerns about political interference with the “independent” central bank, especially after the President appointed his son-in-law the country’s Finance Minister. The Turkish central bank has been reportedly restrained from raising interest rates to quell surging inflation — the last time it raised rates was at an emergency meeting back in January 2014. On Monday, German Chancellor Angela Merkel urged Ankara to ensure the independence of its central bank as a way out of the crisis.

Impact on rupee

The rupee has been on the downslide this year, having slipped 9% in 2018 (it started the year at 63.67 to a dollar) as foreign investors sold $6.8 million and $5.15 billion in equity and debt markets respectively. Turkey’s currency crisis has been the trigger for fresh selling across emerging markets, and the rupee has reacted sharply.

The rupee has been among the hardest hit in Asia from the Turkey-led selloff in emerging assets, largely due to a wide current account deficit (CAD, or the difference between the country’s imports and its exports) that is already strained by higher oil prices. The Finance Ministry has blamed “external factors” for the rupee’s fall; Economic Affairs Secretary Subhash Chander Garg said Tuesday that the external factors may ease going forward, and that there was “nothing at this stage to worry”. SBI Chairman Rajnish Kumar said all currencies have weakened against the dollar, and the Indian currency has not weakened very much in comparison to other currencies.

By The New York Times, Source: FactSet

After the rupee breached the 70-mark Tuesday, traders indicated that the currency recouped some of the losses as state-run banks sold the dollar on behalf of the Reserve Bank of India. The rupee climbed back to 69.90 at the close of the day’s trading.

Analysts maintain that the rupee extended losses Tuesday on account of panic demand from importers, who are buying dollars aggressively. The capital markets brushed off the panic in the currency market, with the BSE Sensex closing 207 points higher Tuesday.

Going forward, analysts expect factors such as the broader trend of currency movements in key emerging markets, the trend in crude oil prices, and the trajectory of the greenback strengthening against other currencies to drive the outlook for the rupee in the short term.

Mixed bag ahead

A falling rupee is very good news for exporters, as it turns exports more competitive. Despite the slide in the value of the rupee relative to the dollar, it needs to be kept in mind that the fallout has negatively impacted most major currencies, especially those from emerging markets. There was a similar selloff at the time the crisis in Greece in 2009, mainly on account of contagion fears across the Euro currency union, but a majority of analysts don’t see the Turkey situation cascading into a crisis of those proportions.

Also, what the rupee is experiencing is a correction of sorts, given that between 2013-14 and 2017-18, its real effective exchange rate or REER — currency’s weighted average in relation to a basket of 36 major currencies that is adjusted for the effects of inflation with regard to the countries concerned — appreciated by 15.9%.

The US dollar is likely to strengthen further in the months to come, with the expected rate hikes by the US Federal Reserve in the coming quarters. According to the investment information and credit rating agency ICRA, the RBI is likely to assess the trend in the rupee vis-à-vis the emerging market currency pack, and if all emerging market currencies are depreciating, the rupee must weaken to protect export competitiveness.

A weaker currency does, however, make imports costlier. High oil prices (India is the world’s third biggest oil importer and ships in about 80% of its crude oil requirements) exert further pressure. The RBI has already hiked interest rates twice in its last two reviews to check inflationary pressures. It has also been intervening in the currency market using its foreign reserves to check currency volatility. In a recent report, the IMF had flagged global risks such as high oil prices and trade tensions among the factors weighing on India’s growth outlook.

There will also be an impact on product prices. Manish Sharma, president and CEO, Panasonic India and South Asia, said that “continual strengthening of the US dollar is putting pressure on the overall input costs”, and that if this trend continues, “it will have an impact on prices within the white goods industry” ahead of the festive season.

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