5 April 2023

Currencies
TRY Turkey

Rich and vulnerable

 The TRY is likely to weaken regardless of the election result Murat Toprak
CEEMEA FX Strategist
 Deteriorated fundamentals and signs of TRY overvaluation HSBC Bank plc
murat.toprak@hsbcib.com
could lead to a wider correction than we previously thought +44 20 7991 5415

 We now see USD-TRY rising to 24.0 by year-end compared

to 21.0 previously

The presidential and parliamentary elections on 14 May could bring changes in the
economic and monetary policies that might be pivotal for the TRY’s outlook over the
medium and long term. However, we continue to believe the currency is likely to go
through a significant adjustment in H2 regardless of the election results.

The TRY’s cyclical and structural vulnerabilities are well known. We have emphasised
in numerous publications the challenges that the currency faces: deeply negative real
rates, a sizeable current account deficit, the absence of stable capital inflows, low FX
reserves and the risk around the sustainability of the lira-isation policy.

If anything, most of these key variables have deteriorated further since the start of the
year. The current account dynamics show no sign of improvement with the trade
balance posting an unprecedented deficit of USD35bn in Q1. The CBRT’s net foreign
assets excluding swaps stay negative even if gross FX reserves are off the lows.
Meanwhile, residents’ renewed appetite for FX-protected deposits mechanically
increases the financial risks for the government’s fiscal balance and the central
bank’s liabilities (see Turkey: Policy challenges ahead, 3 April 2023).

Therefore, the question for us is not if the TRY will weaken in the coming months but
rather by how much it is likely to adjust. In light of the underlying deterioration of the
currency’s fundamentals, we now believe that the USD-TRY move higher could be
more pronounced than we expected previously. This is all the more likely since our
V5 valuation model suggests that the TRY is now overvalued. As our V5 approach is
qualitative, we use our PPP model (Little Mac) to estimate by how much USD-TRY is
likely to rise in H2.

Regardless of who is in charge of the economic and monetary policies from May, we
now see USD-TRY rising to 24.0 by end of 2023 vs 21.0 previously.

USD-TRY forecasts
Q2 23 Q3 23 Q4 23
New 20.0 23.0 24.0
Previous 19.5 20.0 21.0
Source: HSBC
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 Currencies ● Turkey
5 April 2023

TRY is rich

Given the poor fundamentals, we believe that valuation is a good instrument to assess the
TRY’s outlook, particularly after a long period of relative USD-TRY stability. The currency pair
has been in a new trading regime since August 2022, characterised by a slow move higher and
compressed historical volatility. Such a regime is not without consequences on the TRY’s
valuation in a context of high inflation. Since August last year, the TRY’s Nominal Effective
Exchange Rate (NEER) decreased by 6.5% (i.e. depreciation) while Turkey’s inflation was rising
significantly. The fact that CPI rose about 25% over the same period gives a sense of the strong
differences in the dynamics between FX and inflation.

As a result, the TRY has strengthened by about 12% in real terms since the middle of last year,
at odds with the currency’s fundamentals. In the recent update of our V5 valuation model, where
we compared the change in the Real Effective Exchange Rates (REER) to five macro and
financial variables, it was no surprise that the TRY emerged as one of the most overvalued
currencies in the region. The overvaluation signals were significant and constant across all
metrics. (For all details on V5, see CEEMEA FX: Where is the value?, 15 March 2023.)

It is worth emphasising that our PPP model provides a different signal, suggesting that the TRY
is marginally undervalued (Chart 1). However, our Little Mac Index has not been a good guide
for the TRY’s direction over recent years. There are different reasons behind it, in our view. High
and volatile inflation could make it more difficult for our PPP model to identify a currency’s fair
value range. Such an approach also faces the challenges of capturing sudden and sizeable FX
moves like in August 2018 or Nov-Dec 2021, as well as important policy shifts such as the lira-
isation policy implemented since the end of 2021.

1. Our PPP model suggests the TRY is marginally undervalued

Source: HSBC, Refinitiv Datastream

Therefore, our conviction is that our V5 model is a better guide to assess the TRY’s valuation
and this model clearly suggests an overvaluation. However, the V5 approach is qualitative and
does not provide an indication of the scale of an overvaluation/undervaluation. Here, the PPP
model could actually be useful in estimating where USD-TRY could rise to reflect the significant
deterioration in fundamentals.

Our experience is that USD-TRY tends to deviate by about 30-45% from its fair value range
when the dynamics of fundamentals are strongly FX-adverse (Table 2). We believe that the
TRY may have to adjust in a similar manner given the strong macro and financial headwinds.
Such a sizeable TRY depreciation would help to correct the overvaluation suggested by our V5
model, in our view.

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5 April 2023

Table 2. Scale of TRY’s undervaluation in selected past episodes

TRY’s undervaluation vs USD (deviation vs our fair value range)
August 2018 37-45%
November 2020 29-46%
November 2021 29-49%
Mid December 2021 43-59%
Source: HSBC

Hence, if we use the current estimate of our PPP model and assume a TRY deviating by 30-
45% from its current fair value range, USD-TRY would have to rise to a 24-27 range. Given its
poor fundamentals, we believe that the TRY could reach such levels of undervaluation on a
PPP basis and we revise our USD-TRY year-end forecast to 24.0 vs 21.0 previously.

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5 April 2023

Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s)
whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering
analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or
issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other
views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect
their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Murat Toprak

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5 April 2023

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5 April 2023

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