Mixed findings on lira’s fair value


Lira has depreciated sharply in recent years — by some 25% in nominal terms (against a ‘basket’ that comprises 50% euro and 50% dollar) over the past year or so, and some 50% in the past 2.5 years. Does this make the lira undervalued? Judging by the most popular CPI-based Real Effective Exchange Rate index, it seems so. The lira is markedly below (by some 10%) its “long term trend” (proxied by a 5-year moving average; see picture). The latest (July) results of the Big Mac Index is even more dramatic, suggesting over 40% undervaluation.

Yet, there is also some counter evidence that suggests undervaluation is much more limited or there is no undervaluation at all. For instance, the Big Mac’s “adjusted” index (adjusted for per capita income, that is) suggests that undervaluation is much less at around 8%, while the latest installment of Peterson Institute’s FEER calculations shows that the lira is barely undervalued at all. Perhaps most importantly, the IMF’s latest External Sector report (here is the general report; here is country annexes) warns that Turkey is among the most externally vulnerable among the systemically important large countries.

Bottom line? The case for lira’s undervaluation is not as strong as “raw indices” suggest. “Fundamentals” point to a more subtle situation…