Turkish Lira: Managed depreciation fails to remove devaluation risk – Commerzbank

Commerzbank’s Tatha Ghose reports that Central Bank of the Republic of Türkiye (CBRT) Governor Karahan claims a faster Lira depreciation is being allowed to avoid a sharper future devaluation. Ghose argues that USD/TRY remains on a mechanically managed, roughly 20% annualised depreciation path, which is still too slow versus 30–35% inflation. With CBRT cutting rates, he warns that underlying inflation and external imbalances keep long-term devaluation risks for the Lira intact.

Rate cuts and FX management raise risks

"Turkey’s central bank (CBRT) governor, Fatih Karahan, reportedly told investors yesterday that CBRT is allowing the lira to depreciate more quickly in order to prevent the need for a sharper future devaluation. Karahan argued that weaker economic activity has reduced inflation pass-through, making this an opportune time to adjust the currency’s path. There are several problems with this argument:"

"We do not detect a discernible acceleration in the pace of depreciation in recent days or weeks. But, the lira has been on a steady, rapid depreciation path in any case, annualising to around 20% in recent months."

"This straight-line trajectory has been maintained with the help of FX intervention by the central bank and state-owned banks, which is well known and recognised by the FX market. We have often cited the mechanical-looking intraday trading pattern of USD/TRY to argue that the lira is not a free-floating exchange rate in any conventional sense. The familiar pattern remains one of flat segments followed by breaches of successive levels of defence."

"CBRT has entered into a rate-cutting cycle. This may now be sold as a tactically smart move, which consciously targets ‘healthy’ lira depreciation. But rate cuts alongside managed depreciation do not resolve the underlying inflation and balance of payments problems. Inflation cooled for only one month, in a globally pro-inflationary environment. CBRT’s rate cuts only increase risks for the lira."

"Nevertheless, a 20% annualised depreciation rate still means that Turkey’s real exchange rate has been appreciating, given inflation in the 30%-35% region. In other words, nominal depreciation is not rapid enough to eliminate real appreciation or necessarily move the exchange rate towards fair-value. For this reason, it is difficult to agree with CBRT’s assessment that the present currency path is avoiding the risk of a future devaluation."