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Further gloom in store for lira as it hits record low

The Turkish lira plunged to a record low this week, as a political scandal in the country forced Prime Minister Tayyip Erdogan to reshuffle nearly half of his cabinet. Now analysts say a plethora of headwinds are lining up to push the currency even lower.

The currency dropped to an all-time low of 2.14 per dollar on Thursday, weighed down by political uncertainty coupled with the recent announcement that the U.S. Federal Reserve would trim its $85-billion-per-month asset-purchase program by $10 billion starting in January. In early trade on Friday in Asia, the lira was trading at around 2.12.

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Blue Mosque at night, Istanbul, Turkey
Image Source | Getty Images
Blue Mosque at night, Istanbul, Turkey

Erdogan sacked ten ministers on Thursday, almost half of his cabinet, and appointed loyalist names in a bid to secure his power, amid a spiraling graft scandal involving state lender Halkbalk, which saw three ministers resign on Wednesday, one of whom called for Erdogan's resignation.

Each of the cabinet ministers who resigned has a son accused of being involved in the scandal and detained last week. Two remain in custody, Reuters reported, along with 22 other prominent businessmen and local government officials, including the head of Halkbalk.

The scandal has fueled anti-government sentiment that has been brewing since mass street protests swept Istanbul and other Turkish cities earlier this year.

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According to Nicholas Spiro, managing director of Spiro Sovereign Strategy, Turkey's latest corruption probe shows that the full extent of political risk in the country has not been priced in to the currency.

"Investors knew 2014 was going to be a politically driven year for Turkey, but the latest corruption probe has taken things to a whole new level. The investigation has turned into a full-blown political crisis. The lira has long been a focal point for investor anxiety in FX markets, yet never more so than now," said Spiro.

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The lira saw heavy losses earlier in the year amid panic over the U.S. Federal Reserve's first suggestion that it planned to trim its stimulus program, and the currency has lost around 15 percent since the tapering panic first began on May 22.

Turkey is particularly vulnerable to capital flows; although its economy has seen huge growth over the past decade, it imports nearly all of is oil and has a particularly high current account deficit at around 7 percent of gross domestic product.

Spiro said the combination of heightened political risk, Turkey's dire external position and a lack of confidence in the country's central bank makes it all the more vulnerable to shifting U.S. monetary policy.

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"The lira is looking extremely vulnerable right now, throwing the challenges faced by Turkey's central bank - which has its own credibility problems - into sharp relief. The central bank can no longer point the finger at the Fed. This is a central bank which stubbornly refuses to mount an interest rate defense of the lira, making Turkish assets even more vulnerable," added Spiro.

(Read more: Turkish Finance Minister: Protests a 'Hiccup' for Economy)

Earlier this week Turkey's central bank attempted to boost its domestic currency by selling at least $6 billion in foreign currency by the end of January. The move did provide some respite, lifting the lira to 2.0580 on Wednesday, before it was knocked back down by the renewed political uncertainty.

Chris Weston, currency strategist at IG's Sydney desk, agreed that a combination of factors were putting downward pressure on the lira at present.

"The fundamentals are poor without this saga going on anyway. In the emerging market space Turkey's got one of the widest current account deficits. Some emerging markets have done well to address bond outflows, but these guys haven't done anywhere near as much as India for example," he said.

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Weston added that although the Turkish central bank has been taking steps to stabilize the lira, in reality the moves may not be sufficient, particularly given the country's external financing requirements next year at $215 billion, which far outweigh its $42 billion of FX reserves.

"Currency intervention halts the slide and can create short covering but it's not going to be enough to warrant taking a long-term position on the lira. So you have the government doing one thing and the central bank basically having to try and undo all the negative work. It's a recipe for further weakness, even though a lot has already been priced in," he said.

— By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie

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