Capital flows to play critical role in dollar-lira exchange rate in 2018

Published 04.01.2018 00:00

While a year has gone with a high demand for the dollar because of geopolitical risks and central banks' strategies to normalize monetary policies, it is expected that rising interest rates, inflationist pressures and global uncertainties, affecting capital flows, will be the main factors dynamics to direct dollar-lira exchange rates in 2018.

Increasing global geopolitical risks on a global scale and the concomitant uncertainties, both economically and politically, dominated markets last year.

The dollar index fell by nearly 10 percent, closing the year at 92.1 percent, in 2017, when central banks accelerated their steps to return to normality in monetary policies following the global economic crisis.

As a result of geopolitical risks and uncertainties and the rise in foreign interest rates, despite the decline in the dollar index, and as well as the rising inflationary pressures in Turkey, the dollar-lira parity reached an all-time high at 3.9830. The dollar-lira exchange rate stood at 3.7905, with a 7.5 percent upsurge, at the end of 2017.

Economists noted that the central banks's moves toward normalization, geopolitical risks and the course of inflation will determine dollar-lira movements in 2018, emphasizing that continuing interest in lira assets will be the most important factor supporting the exchange rate. Economists pointed out that the dollar-lira exchange rate will pursue 3.70-3.75 bands in the short run, adding that if the supportive level of 3.7 is broken, the 3.65 level will be on the agenda.

QNB Finansinvest Chief Economist Burak Kanlı told Anadolu Agency (AA) that the sharp rise observed in the dollar-lira parity in the last quarter of last year is expected to give way to a fluctuating course in the first quarter of 2018.

Expressing that he expects that the appreciation of the lira will continue for a while, Kanlı stated, "Within this framework, it is possible to say that the 3.65-3.70 band is a reasonable level for lira, but I do not expect it to fall under this band."

Kanlı predicts that the inflation will enter a downward trend due to the slowdown in economic demand and base effects of inflation in the upcoming period. He said, "This will lead to an increase in the real interest rate given by the Central Bank of the Republic of Turkey and will ease the concerns about the exchange rate. The critical issues for the exchange rate here will be how much inflation will fall and whether the central bank will enter a new early relaxation process in monetary policy."

Stating that the trend of depreciation in the lira will continue throughout 2018, Kanlı said, "We predict that inflation in the Turkish economy will remain clearly high in 2018 when compared to other countries. The relatively low increase in productivity in the whole economy in recent years has had an impact in the medium and long run."

Underlining that the exchange rate is likely to be above current levels at the end of 2018, Kanlı stated, "I expect it to be around 4.2 at the end of the year. The beginning and end of the year 2017 was challenging for the lira, while the midyear was relatively stable. Challenging periods have gone as a result of the central bank's interest rate hikes."

According to Kanlı, despite the high global risk appetite and intense capital flows into emerging economies, the lira experienced clear depreciation against the currency basket last year, lagging behind other developing country currencies. He continued, "In fact, we have been familiar with this picture in recent years. While political and geopolitical developments affect the country's risk premium, high inflation and low productivity gains, which are not at the desired levels, affect the lira's weakness."

Ziraat Bank Economist Bora Tamer Yılmaz also noted that the 3.95 level was carefully watched in 2017 in the exchange rate in technical terms, adding, "Authorities reacted verbally or in different forms as the parity approached this level. If this level were broken, we would face a new regime."

Yılmaz expects that a withdrawal to the 3.70-3.75 band with the defense of the 3.95 level, saying that technical formation was completed in the last days of last year. He pointed to two possibilities for the course of the lira this year, adding, "The first one is that if the exchange rate remains stable in the real basis, it will depreciate in direct proportion to inflation in the nominal basis. The second possibility is the stability in the nominal exchange rate in line with risk appetite and capital movements."

According to Yılmaz, currently, global economic activities and foreign demand are strong. Developing country currencies are making use of the dollar's weakness. For instance, the South Korean won has been valued up to the 1.067 level. In comparison, the lira is protecting its competitive power. Economic developments will determine the approach about the real exchange rate. The average exchange rate was at 3.65 in 2017. If the real exchange rate is fixed, the nominal (spot) exchange rate average this year may depreciate in direct proportion to inflation.

Expressing that the direction of global capital movements last year flowed toward developing countries from developed countries, Yılmaz noted that lira assets also attracted international investors and about $10 billion in investment was made.

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