“Fragile Five” was the name coined by a little-known research analyst at Morgan Stanley in 2013 summer to a group of Emerging Market currencies mostly for their sensitivity against Dollar. These were the Brazilian Real, the Indonesian Rupiah, the South African Rand, the Indian Rupee, and the Turkish Lira. In the five years past, there have been several rewording of the term from multiple sources including Morgan Stanley which failed to improve the image of these currencies and thus economies. Now that the Trump administration steps up its game on tightening the reins of trade and foreign relations with the world, it’s time to see what affects one special member of the FF: The Turkish Lira.
Action: Trump appoints John Bolton as his National Security Advisor
John Bolton, U.S. President Donald Trump’s new National Security Advisor, can be called a “conservative hawk” at best and a “dangerous and reckless neoconservative” at worst. He had been at the focal point of the media before during George W. Bush’s first presidency where he said “We are confident that Saddam Hussein has hidden weapons of mass destruction and production facilities in Iraq.” We all know how that turned out which led to the destabilization of the entire region.
Convincing US on Syria Operations Just Got Harder
Bolton has been a hard-line conservative that said “It’s a Turkey that’s moving away from the West, but also a Turkey that’s moving away from NATO,” in late 2016. Upset by Turkish negotiations with Russia and Iran on Syria that totally bypassed United States, Bolton said at the time that it was an effect of diminishing US influence on the region under the Obama administration. Now that he is the lead bureaucrat on the topic, we can expect the U.S.-Turkey negotiations take a different shape on how far Turkey can go into Syria. To summarize:
What’s the effect on Lira?
Turkey has an upcoming presidential election in 2019 and although regularly denied by AK Party, rumors of an early election in 2018. During any election year, the foreign direct and portfolio investments into Turkey slow down with the foreign investor cautious on the result that needs to favor political stability. This in return pressures Lira against counterparts, mutes Dollar based performance of the Turkish equities and disrupts Turkey’s current account balance.
So far, Turkish operations in clearing Northern Syria from PKK/YPG has been favoring President Tayyip Erdoğan and AK Party. A possible delay or a turn to negative caused by John Bolton’s influence on Trump might cause the excitement factor to diminish on Turkish nationalist voter base which was the key factor in the previous elections.
Although Erdoğan doesn’t critically need the Syria operations to continue to get the majority of the votes, he might prefer to keep on going to keep the AKP and nationalist MHP election coalition healthy and secure the nationalist voter base.
Action: Trump Declares Trade Tariffs
Earlier this month, President Trump announced he would impose sweeping tariffs on steel and aluminum imports. The tariffs–of 25 percent and 10 percent on steel and aluminum, respectively–are set to take effect this week. Mexico and Canada was temporarily exempted from these tariffs from the start which got expanded to Argentina, Australia, Brazil, South Korea, and the EU later on. Turkey is not on the exemption list.
The obvious implication of Trump’s trade tariffs on steel and aluminum imports for Turkey has been covered by the media in the previous weeks. Out of a total steel exports of $8.25 billion, Turkey exported about $1.12 billion worth of steel to United States in 2017 which comes to about 14% of the exports. On the U.S. side, Turkey is one of the larger sources of steel with about 9% of the market share of U.S. steel imports.
While the numbers might seem significant, we need to factor in the price difference of the two countries. Turkish steel is exported to United States for around $600 per tonne while the price in U.S. is at $850. With the 25% import tariff imposed on steel, the price rises to $750 which is still competitive compared to what the U.S. steel producers can offer.
That said, this is still negative news for part of Turkish economy which might or might not impact the Turkish Lira in the medium-long run depending on the negotiations that will take place between Turkey and United States on it.
Risk of U.S. – Chinese Trade War on Lira
The real risk of Trump’s tariffs on the Lira might actually arise from his actions against China. Trump’s decision to impose import tariffs on China anywhere between $50 to $60 billion is a greater risk for the global economy and in return, the Turkish Lira, than the steel import tariffs or geopolitical decisions.
While the United State’s $19.4 trillion economy is at the top of the world in size, China is a solid second with $11.9 trillion. U.S.’s economic machinery is highly dependent on imports from several countries with China taking a biggest share at goods imports totaled $462.6 billion in 2016. EU is second with $416 billion and Canada is third with $354 billion in imports. A trade war between one or more of these countries or regions will in turn increase the dependence on local production which would be significantly more expensive than the imported goods. The final outcome of this chain is higher priced purchased goods which is shortly called “inflation”.
Inflation in United States means a heating up economy and in return a Federal Reserve who might be set to increase their policy interest rates at a much steeper angle. The catch for Turkey is that, FED actions directly affect the Emerging Markets, especially the “Fragile Five” where the current account balance is sensitive to foreign investment and the currency to the American interest rate expectations. Unexpected moves in FED policies weaken the currency in these countries and push the inflation higher.
Inflation and Current Account Balance
Inflation has been a long-time trouble for Turkish economy as it’s part of Turkey’s endless growth-currency devaluation-inflation cycle. As a foreign inflow thirsty economy, Turkey is susceptible to political and economic tides which hurt the economy nine out of ten cycles. The only positive outcome of these foreign economic effects that comes to mind recently were after the 2008 world economic crisis where, thanks to FED, low interest rates allowed waves of carry trade reach Turkish shores and pulled inflation down to 5% range.
In addition, since 2013, Turkey’s economic leadership has been pushing forward a combination of policies that promote state-backed growth, limit interest rate hikes from Central Bank of Turkey and increase taxation on imported products. While these have allowed exports to improve over time, improving the current account balance, the cost of imported products have risen by a boost in domestic credit backed spending that prevented inflation to back down.
The Cure: Foreign Inflow from MENA Region
Divesting from European Union and investing in MENA has been a primary international trade and investment tactic during the AK Party reign from the start. Before and during the Arab Spring, Turkish companies, led by construction sector, were landing governmental contracts in the Gulf Region and North Africa. Recently, things got more political with Saudi Arabia’s powerful Crown Prince Mohammed bin Salman, who just this month named Turkey in a “triangle of evil” along with Iran and hardline Islamist groups. While this might be seen as a departure from Turkey, the Turkish business was focused on the other part of the Arab world led by Qatar.
The current volatile political environment in the Gulf is actually a positive sign for foreign investment into Turkey. Based on a report by Turkey’s Anadolu Agency in July 2017, Foreign Direct Investment from Gulf countries in Turkey grew a staggering 397 percent to reach $552 million between January and May of 2017, compared to $111 million in the same period of 2016. Comparably, in January 2018, non-residents’ deposit accounts in Turkey grew by $2.7 billion, a 5% increase compared the the year before on a monthly basis. Another recent event was one where Emirates NBD agreed to buy Turkey’s Denizbank this month, a potentially $5.3 billion deal despite a diplomatic rift between two countries.
It’s no secret that Turkey is coming to an election season and foreign investment in Turkey is conservative at best during these times. That said, according to the Central Bank of the Republic of Turkey (CBRT) data, Turkey received $7.4 billion in foreign direct investment (FDI) in 2016, which is the year after the 2015 elections. $2.9 billion out of the $7.4 was from Gulf Countries alone. If the rumors of a 2018 early election comes out correct, it is easy to expect 2019 to be a bright year for Turkey and the Turkish Lira with the help of the investment inflows from the MENA Region.