By Emre Peker and Yeliz Candemir
ISTANBUL--Turkey's currency slumped to its lowest since Prime
Minister Recep Tayyip Erdogan led his party to a decisive victory
in March local elections, with a broader emerging-market rout
hitting the lira hard just four days before the country's first
popular presidential vote.
The lira slumped by as much as 0.84% to 2.171 per dollar by
midday on Wednesday, the lowest since March 31 and the leading
loser among emerging-market currencies. The lira has fallen by 3.5%
since July 25, when Turkish markets went on a five-day post-Ramadan
holiday. The government's benchmark two-year bonds also fell, with
yields soaring to a three-and-a-half-month high of 9.67% from 8.74%
last week.
As global markets drop on tensions driven by the Ukraine
conflict, domestic concerns led by central bank's dovish monetary
policies, persistent government calls for interest rate cuts amid
stubbornly high inflation, and speculation that Moody's Investors
Service could downgrade Turkey to junk status are once again
stoking volatility in Turkish assets.
"We expect the negative sentiment to continue," said Nilufer
Sezgin, chief economist at Erste Securities in Istanbul.
The market rout comes as Mr. Erdogan is poised to clinch the
presidency on Sunday, potentially extending his rule for another
decade in a bid to more than double Turkey's $820 billion economy.
The premier is polling an average 54% support, compared with under
40% for the joint-opposition candidate.
But challenges abound, especially with U.S. data signaling an
economic boom that could herald the beginning of interest rate
rises by the Federal Reserve. That would start draining the flood
of cheap cash that had been underwriting growth and plugging
funding shortfalls in emerging markets such as Turkey, reversing
the flow of money back to developed economies.
"As the U.S. economy appears to be stirring from its pre-summer
siesta, an air of unease is beginning to pervade emerging markets'
shores once again," said UBS strategists led by Bhanu Baweja in
London. "The market has moved forward and priced in more aggressive
action from the Fed next year."
The anticipated policy tightening in the U.S. and in other
emerging markets jar with calls for a looser stance in Turkey,
where government officials persistently press the central bank to
support economic growth by reducing borrowing costs.
This week, Economy Minister Nihat Zeybekci once again called on
Governor Erdem Basci to cut interest rates, even as data on Monday
showed inflation accelerated to 9.32% in July from 9.16% in
June.
The jump defied central bank forecasts that inflation would
start slowing down in June, rising instead to almost double the 5%
official target. Resurgent inflation also indicates that contrary
to Mr. Basci's claims, price increases are broad-based and not
restricted to food costs.
"Contrary to [market] calls that interest rates shouldn't be
lowered at the next Monetary Policy Committee meeting because
inflation is higher than expected, we [the government] argue that
rates should be cut until the expectations of producers, investors
and exporters have been met," Mr. Zeybekci said on Tuesday. The
central bank's next decision is due on Aug. 27.
Turkey's economy minister also said his expectations are on the
"negative side" with regards to the Moody's report on Turkey due on
Friday. His comments were echoed by Salih Kapusuz, a lawmaker from
Mr. Erdogan's governing party.
"We know that credit-rating firms like Standard & Poor's,
Moody's have previously cut Turkey's credit rating on subjective
criteria," Mr. Kapusuz said Tuesday in messages from his Twitter
Inc. account, referring to a belief that the country's credit
ratings are driven by political calculations, and not economic
merits. "There is speculation of certain efforts to cut Turkey's
credit rating before elections, we hope they're not true," he
said."
Economy Minister Zeybekci later said in a tweet that he doesn't
anticipate a downgrade from Moody's. On Wednesday, Deputy Prime
Minister Ali Babacan, who is in charge of all the economy-related
ministries, also said the Treasury hadn't received a signal from
Moody's about a rating cut.
A London-based spokeswoman for the ratings firm pointed to
Moody's ratings release calendar and declined to comment on how
Friday's report may affect Turkey's Baa3 rating, the lowest
investment grade, which carries a negative outlook.
Turkey's central bank has been cutting its benchmark rate since
May, when the current-account deficit declined to $48 billion from
$65 billion in 2013--shrinking to 5.8% of gross domestic product
from 8%--and as exports helped rebalance economic growth away from
credit-fueled consumer spending. Policy makers have reduced the
one-week repo rate to 8.25% from 10%, and they are expected to
continue easing their stance.
"In late August, the central bank is likely to, for the fourth
time in a row, yield to Erdogan's pressure to cut interest rates to
stimulate growth," said Amy Yuan Zhuang, an analyst at Nordean Bank
AB. "Turkey's large external financing need combined with the
prospect of less easy monetary policy from the Fed will curb
capital inflows, also lira negative."
Write to Emre Peker at emre.peker@wsj.com and Yeliz Candemir at
yeliz.candemir@wsj.com