Where is the Turkish Lira Headed?

This has been a wild week for the Turkish Lira, which has seen wild swings in the order of 6% or more in either direction. It is true that the markets' current worries about the foreign-funded FX lending in Central and Eastern Europe and the related exposure of Western European banks does not apply to Turkey. The country's banking system is solid with no exposure to the toxic assets plaguing the banks in the US and Europe. The Turkish banks have the lowest loan-to-deposit ratio and the smallest external indebtedness as a percent of the GDP in Eastern Europe. The slowdown that is currently setting in is directly related to shrinking export markets in Europe, Turkey's main trading partner.

The cause of the extraordinary volatility has been blamed on the external fear factors such as the recent events surrounding GM, GE and Citibank and the decision of a couple of foreign banks to liquidate their Turkish assets. The ensuing Central Bank decision to start foreign exchange auctions have had a calming effect on the Lira.

I beleve we are entering a critical period for the Turkish Lira that spans the end of March-early April. Turkey is slated to have local elections on March 29, where the governing AKP Party is expected to win most municipalities. These approaching elections have acted as a brake on the government's willingness to conclude a $20-30 billion new stand-by agreement with the IMF. The lack of an IMF agreement coupled with agressive interest rate cuts by the Central Bank has decresed the attractiveness of Lire denominated assets.

Turkey is a member of the G-20 that will be meeting on April 2. This will be followed by the NATO summit on April 3-4 and President Obama's visit to Turkey. The latter event is important because it will highlight Turkey's status as a regional power and an energy corridor for the West.

The optimistic scenario to which I subscribe would be for the AKP to get a renewed mandate in the local elections and have the political will to sign an agreement with the IMF around the time of the April summits. Syncronizing the IMF agreement with the Obama visit and the announcement of further political (Kurds, new constitution) and economic reforms to give new impetus to the EU accession talks would have a very good chance of stabilizing the Lira in a much lower band than we have observes this week.