Turkish lira: USD/TRY hits record high thanks to corruption scandal and tax hikes

Existing problems for Turkish financial markets awakening on New Year’s Day were compounded today by the realisation that everyday goods such as gasoline, tobacco, alcohol, cars and mobile phones had indeed all gone up in price with the commencement of consumption tax hikes announced just the day before.

The Turkish lira has slumped to a new all-time low against the US dollar today, with the USD/TRY reaching 2.1873, an historical high for the pair. In December, the lira fell the most since September 2011 as a corruption probe entangled the cabinet of Prime Minister Recep Erdogan and led to the resignation of three ministers.

And lira-denominated government bonds have also extended their downtrend today, after dropping 20 percent in 2013, a slide beaten only by the Indonesian rupiah. The havoc in the markets has been accompanied by widespread national protests demanding the resignation of Erdogan and his entire cabinet.

“Markets knew that 2014 was going to be a politically driven one for Turkey. But the escalating corruption probe suggests that political risks in Turkey have been underpriced,” observes Nicholas Spiro, head of Spiro Sovereign Strategy.

The Turkish Finance Ministry announced on 31 December that it would ramp up a number of levies the next day, including the private consumption tax known as OVT and the value added tax on selected everyday goods.

The government also said that it would raise the net minimum wage in the country by five percent in the first half of 2014, to be followed by another hike of six percent in the second half. Thus, the monthly minimum wage will rise to 891 lira or around $428.

In a client note, BNP Paribas economists wrote earlier today that the devaluing lira and latest tax increases will “likely push end-14 CPI inflation to 7.5-8 percent from an earlier projection of 6.8 percent”.

This year, according to Simon Quijano-Evans, head of emerging-markets research at Commerzbank, “we will continue to see the weaker current-account stories including South Africa, Indonesia and Turkey under pressure as U.S. treasury yields continue to head north”.

The Turkish lira has been one of the main losers from the Fed taper-fed panic among investors in developing economies, after the US Federal Reserve started in mid-2013 articulating the prospect of reduction in its bond-buying programme.

The chart below illustrates how the an index of USD/TRY and USD/ZAR (the South African rand) has tracked closely the surge of US 10-year government bond yields since the first taper hints on 22 May last year.

Meanwhile, PMI data compiled by HSBC has the Turkish manufacturing sector losing momentum in December. The Manufacturing PMI checked in earlier today at 53.5, down from the 32-month high of 55.0 set in November. New export orders and business purchases expanded in December, albeit at a slower pace than November.

Commenting on the reading, HSBC economist Melis Metiner said: “Looking forward to 2014, we would expect to see some deceleration in domestic orders as household spending slows on the back of higher interest rates and a weaker lira. But the foreign demand outlook is set to improve next year, which could support exporters’ performance.”

Currently, the USD/TRY is trading at around 2.1841, up 1.64 percent intraday.