Turkey's Lira Post-Election Prospects and Dual Exchange Rate Concerns

As Turkey's presidential and parliamentary elections on May 14 approach, the country's economy faces significant challenges. Analysts at JPMorgan predict that the lira could drop sharply, nearing 30 to the dollar if only modest changes are made to Turkey's unorthodox economic policies. These elections mark a critical juncture for Turkey, as international investors have been withdrawing from the country due to recurring market turmoil.

According to JPMorgan's analysts, macro adjustments are expected regardless of the election results. They outline two scenarios based on the commitment to more orthodox policies such as interest rate increases to combat inflation. In a "strong commitment" scenario, the lira would initially fall to 24-25 to the dollar, then to 26 by year-end, compared to its current rate of around 19. Benchmark government bond yields, which drive borrowing costs in the economy, would jump to 25%.

On the other hand, if the shift toward more orthodox policies is more modest, the lira could drop closer to 30 to the dollar by year-end, albeit with a slower initial drop, while bond yields would not adjust much in this scenario. JPMorgan's analysts warn that the path to disinflating the economy will be protracted, even with the best intentions. They also expect that the central bank would aim to rebuild its foreign exchange (FX) reserves.

JPMorgan estimates that the lira's real effective exchange rate (REER) is now about 32% below its "fair value." A return to orthodox macroeconomic policies could set the lira on a real appreciation trend back toward its fair value. However, initial real appreciation will likely be driven primarily by prices, with little scope for FX spot appreciation.

Amid these challenges, a dual exchange rate has emerged in recent months. Turkey's finance minister, Nureddin Nebati, suggests that the central bank's regulations might have contributed to the spread between the official and parallel markets. In response to this, authorities plan to eliminate the spread in the rates through "new regulations" and by breaking expectations for a devaluation after the elections. Nebati also emphasized that Turkey would not raise interest rates after the elections.

In contrast, central bank Governor Sahap Kavcioglu denied that Turkey had a dual exchange rate. Still, the central bank has taken exceptional measures to defend the currency, such as tweaking rules for gold trading to support the lira's value in the bazaar and briefly narrowing the gap with the official interbank rate.

The Turkish lira remains stable in early trading, as investors follow the Federal Reserve Bank's decision to raise the interest rate by 25 basis points. The lira has not been affected by strong movements in various markets, such as gold, oil, and other major currencies, due to the Turkish Central Bank's continued control over the lira's price.

Several international institutions predict losses for the Turkish lira in the post-election period, regardless of the election's outcome. They also anticipate that the country's interest rate will rise to near 40% levels before declining to about 23% by year-end. Recent data reveals that inflation in Turkey dropped to 43.68% in April, compared to 51% in March.

On a technical level, the USD/TRY pair remains stable, trading above support levels of 19.40 and 19.34, but below resistance levels of 19.50 and 20.00. The pair is moving above the 50, 100, and 200 moving averages on daily, four-hour, and 60-minute time frames, indicating a strong general upward trend. However, due to differences 

in monetary policy and the economic situation in Turkey, any drop in the dollar against the lira represents an opportunity to buy back again. Investors are advised to adhere to the numbers in the recommendations while maintaining capital management.

As the elections approach, the future of Turkey's economy hinges on the commitment to more orthodox policies. The possible outcomes range from a strong commitment that may cause the lira to fall initially but eventually stabilize, to a more modest approach that could lead to a more protracted depreciation path. Market participants will have to evaluate these scenarios carefully and anticipate elevated volatility, as outlined by JPMorgan's analysts.

The emergence of a dual exchange rate further complicates the situation, prompting authorities to take measures to address the disparity between the official and parallel markets. It remains to be seen how effective these new regulations will be in eliminating the spread in the rates and breaking expectations for a devaluation after the elections.

The country's inflation rate, which has recently experienced a decline, is another crucial factor to consider. If Turkey can continue to lower its inflation rate while navigating the challenges posed by the elections, it may be able to stabilize its economy and regain the confidence of international investors.

Overall, the outcome of the May elections will have significant implications for Turkey's economy and its international standing. Investors and policymakers alike must prepare for a range of potential scenarios, from a strong commitment to more orthodox policies that could help stabilize the lira, to a more modest approach that might prolong the currency's depreciation. As the situation unfolds, market participants should remain vigilant and exercise caution to navigate the uncertainty surrounding Turkey's economic future.