The strategists who predicted this month’s tumble in the lira say more declines are likely as Turkey’s failure to cut its record current-account deficit erodes investor confidence. Royal Bank of Scotland Group Plc and Societe Generale SA say the lira may drop as much as 4.8 percent to 1.80 per dollar, extending a 5.3 percent retreat in July, the biggest worldwide. Traders are paying the most in a year to protect against lira depreciation in the options market, with contracts suggesting a 69 percent chance that the currency will weaken to 1.80 by the end of 2012, from 1.7139 yesterday, data compiled by Bloomberg show. The lira hit an all-time low of 1.8243 in March 2009. Turkey’s central bank kept benchmark borrowing costs at a record low for a sixth straight month on July 21, counting on a weaker lira to narrow the current-account gap by boosting exports and making imports more expensive. The strategy has proven unsuccessful as the 12-month deficit widened to $68.2 billion in May. The lira’s slide may fuel inflation in Europe’s fastest-growing economy and drive away the investors Turkey relies on for funding, according to Tim Ash, a London-based emerging market strategist at RBS. “Turkey needs to get its act together because there is the potential of having a proper explosion there,” Plamen Monovski, the London-based chief investment officer of Renaissance Asset Managers, which oversees about $2.2 billion, said in an interview. “The central bank has enough resources to contain a currency crisis, but it’s completely unclear why we need to be going through all these motions.” Most Bearish RBS, SocGen and Citigroup Inc. were the most bearish lira forecasters among 21 banks surveyed by Bloomberg in June, predicting a decline this quarter even as the average forecast was for a gain to 1.56 versus per dollar. Luis Costa, an emerging-market strategist at Citigroup in London, wrote in an e-mailed note today that he still recommends “short” lira positions, or bets that the currency will decline. The lira weakened 1 percent yesterday, paring an early drop of as much as 2.2 percent after the central bank said it ended daily dollar purchases. It costs 330 basis points, or 3.3 percentage points, more for one-month option contracts granting the right to sell the lira than to buy the currency, compared with 230 at the start of the month, according to so-called risk- reversal rates compiled by Bloomberg. “It does not seem that the market is going to stabilize at this level,” Benoit Anne, head of global emerging markets strategy at SocGen in London, said in an e-mail. “Market participants still don’t want to go long.” Bonds, Stocks Yields on Turkey’s benchmark bonds rose 20 basis points to 8.88 percent yesterday, according to an index compiled by RBS. The ISE National 100 Index (XU100) of shares rallied 2.1 percent, snapping a seven-day retreat that had sent it to a four-month low. About 40 percent of Turkey’s $37.2 billion current-account deficit in the first five months of the year was funded by portfolio investment, according to central bank data. “Turkey needs capital inflows to finance its huge current account deficit,” Murat Toprak, a currency strategist at HSBC Holdings Plc in London, said in an e-mailed response to questions. “A wide lira depreciation may deteriorate confidence and impact capital inflows.’ The lira rebounded from its lows yesterday after the central bank said it ended daily purchases of $30 million. Turkey has about $93 billion of foreign-exchange reserves, the world’s 20th-largest holdings, according to data compiled by Bloomberg. Central bank policy makers will probably use more “hawkish” public comments to stem the lira’s slide and may raise interest rates in October, according to Thu Lan Nguyen, a currency strategist at Commerzbank AG in Frankfurt. Fastest Growth Turkey’s economy, home to about 79 million people, expanded at an 11 percent pace in the first quarter, faster than any other member of the Group of 20 nations. Inflation fell to a 6.24 percent annual rate in June, lower than the 7 percent median estimate in a Bloomberg news survey of economists. The lira’s retreat “does look a bit overdone,” Nguyen said in e-mailed comments. She expects the Turkish currency to strengthen to 1.61 per dollar by the end of September. Recent statements from central bank policy makers signal they will tolerate further weakness in the lira, according to RBS’s Ash. Turkey can have “a more comfortable free-floating currency” because consumers and businesses don’t have large foreign-currency positions, the central bank’s Basci said in a speech in the southwestern city of Denizli on July 22. Nations with free-floating currencies are able to control interest rates more effectively, he said. ‘Green Light’ Basci’s comment “suggests almost a green light for further lira weakness,” Ash said in an e-mailed note. Turkish Prime Minister Recep Tayyip Erdogan’s government may be exerting pressure on the central bank to keep interest rates low, according to Nomura Holdings and UBS AG. “There is a sense that there is some pressure on the bank to refrain from rate hikes as far as possible,” Manik Narain, an emerging-market strategist at UBS in London, said in a phone interview. Erdogan told an Islamic businessmen’s association on May 3 that he wants to make interest rates “virtually zero” after subtracting the inflation rate. Trade Minister Zafer Caglayan said this month that the current account gap doesn’t pose a threat, according to a report on Bloomberg Haberturk television. Bank Independence “Erdogan’s comments on real interest rates weren’t timely from a central bank independence perspective,” said Olgay Buyukkayali, a strategist at Nomura in London. Policy makers should raise rates because the current-account deficit is growing to “unmanageable” levels, he said. Fitch Ratings said on July 21 that an upgrade of Turkey’s credit rating is “uncertain” and the results of the central bank’s policies are “mixed at best.” A central bank official reached by telephone yesterday who asked not to be named declined to comment. “The biggest risk is that inadequate policy action now might require a bigger policy response later on, increasing the risk of a sharp slowdown in economic activity,” said Berna Bayazitoglu, an economist at Credit Suisse Group AG in London. “The sell-off might continue until we see a policy response from the central bank.” To contact the reporter on this story: Michael Patterson in London at mpatterson10@bloomberg.net. To contact the editor responsible for this story: Gavin Serkin at gserkin@bloomberg.net.

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