Political uncertainty likely to weigh on capital inflows into Turkey and TRY in near term

Persisting political uncertainly is likely to spell doom for capital inflows in Turkey in the near term and thus on the nation's national currency lira. Turkish government imposed a three-month state of emergency on Wednesday night, following a recent development of nearly 60,000 officials, mostly government, either removed or suspended from their posts.

Post-emergency, the state permits the President Tayyip Erdoğan to set up decrees that are immediately effective and are not subject to review by the constitutional court, said Danske Bank.

In the mean time, S&P lowered its foreign currency rating on Turkey on Wednesday to ‘BB’, from ‘BB+’ with a negative outlook. It also lowered Turkey’s local currency rating from ‘BBB-’ to ‘BB+’ with a negative outlook.

The rating agency said that after the attempted coup on July 15, the country’s political landscape has fragmented more that would hurt Turkey’s investment environment, capital inflows and growth. Therefore, there is an increase in the threats to the nation’s ability to roll over its external debt, stated Danske Bank in a research note.

Since the attempted coup on  July 15, the Turkish lira has depreciated about 6 percent. The downgrade of rating and the state of emergency contribute to the risks for the Turkish lira. The country still has quite a huge current account deficit of about 4 percent of the GDP and there requires inflows of capitals. Worries that whether economic policies would alter and the reform process would fall apart might be a drag on short-term portfolio inflows that might also be impacted by threats of additional lowering of rating, added Danske Bank.

About 30 percent of Turkey’s government bonds are owned by foreigners. Emerging market investors might shift out of Turkey and move to Brazil, given its political predictability.

“In light of the changed political landscape in Turkey, we have lifted our USD/TRY forecasts to 3.12 in 1M (from 2.95), 3.20 in 3M (2.98), 3.25 in 6M (3.03) and 3.35 in 12M (3.05),” said Dankse Bank.

Meanwhile, the country’s comparatively strong economic growth is expected to give some support to the currency in the medium term. The current political chaos in the country is unlikely to show any wider effect on global risk appetite and the risky assets’ performance, according to Danske Bank.