A Look At The Turkish Lira

The Turkish lira (TRY) has been hammered on the back of the escalating market turmoil in emerging Asia and worries about Fed tapering. Turkey's large current account deficit is clearly the main worry for investors.

Turkey continues to run a sizable current account deficit and foreign direct investments have plummeted since 2008. The country is very dependent on portfolio flows but these have been drying up as the spillover effect from Asia is being felt and as markets are pricing in the beginning of an exit from quantitative easing in the US.

Given Turkey's sizable current account deficit, we are not surprised that TRY has been under significant pressure. We have been fairly bearish on the outlook for TRY for a long time and as long as the turmoil in the Asian markets continues and the fear of Fed tapering persists, we believe the currency is likely to remain under pressure.

However, we would also note that the sell-off in TRY is good news for Turkey's current account and the deficit should decrease as TRY weakens. Furthermore, commodity prices in general have come down, which is helping the current account situation in Turkey, as is the Turkish economy being likely to slow down further on the back of the latest shock from global markets. Hence, it is probably fair to assume that the current account situation is improving, which in reality should lead to a strengthening of TRY - at least from a fundamental perspective.

However, even if we do not factor in any major improvement in the current account situation, our fair value models for TRY indicate that the currency is no longer significantly overvalued. So, while we are not bullish on TRY, it is clear that once sentiment in global emerging markets stabilises, the TRY could strengthen - or at least stabilise.

TRY To Remain Volatile
Concluding, the TRY sell-off is natural given the deterioration in global emerging market sentiment and the worries about Fed tapering. The TCMB's attempts to curb the sell-off are unlikely to succeed as long as the turmoil continues. Furthermore, political risks in Turkey are elevated and are likely to remain that way until next year's elections.

We would not recommend buying TRY at the current level given the global financial situation right now. However, TRY can no longer be said to be fundamentally overvalued - even though it is not outright cheap - and we would expect it to stabilise once the global financial situation calms down.

Hence, for investors with a time horizon of longer than six to 12 months, there might be some value in long lira positions.

Read our outlook on the Turkish lira in Flash Comment: Turkey - TRY inching closer to fair value , August 22.

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