Turkey’s central bank cannot stabilise the lira for much longer

After spending $40 billion in 2019 and over $20 billion so far this year in an attempt to control foreign exchange rates, the Turkish authorities have failed to achieve their goals of protecting the country from economic and financial turbulence.

Despite the powerful interventions that the central bank has carried out in currency markets with the help of state-run banks, the average price of the lira has continued to drop since the beginning of 2019.

Whereas the lira traded at 5.31 per dollar at the start of 2019, in the 15 months since it has slid to 6.6 against the U.S. currency. The lira is now weaker than it has been at any time since the height of a political crisis with the United States over the imprisonment of a U.S. pastor in the summer of 2018, which helped spark severe currency turmoil.

The drop in the lira, especially during the past month, is due to both internal and external factors. As the coronavirus crisis deepened, oil prices slumped, markets have crashed and many countries’ currencies have crumbled.

In the face of double-digit falls in currencies such as the Russian ruble and the Mexican peso, the lira performed comparatively well last month. Still, when we take certain internal and external factors into consideration, making a more pessimistic forecast for the lira compared to other currencies is most likely the correct one.

For example, unlike Russia, Turkey does not have hundreds of billions of dollars of foreign currency reserves, or direct swap agreements with the U.S. Federal Reserve, like Mexico. These countries also do not find themselves backed into a corner by foreign currency-denominated corporate debt in the way that Turkey does.

Since they have not spent the past two years using up precious financial resources in an effort to defend their currencies, countries such as Russia and Mexico are in a stronger position. Furthermore, these countries and many others are not as dependent on their tourism industries for vital foreign currency earnings in the way Turkey is. With no end in sight for a resumption in the flow of visitors into Turkey and much-needed export sales severely depressed, the next few months will likely herald highly traumatic upheavals for the lira, a key barometer of the country’s overall economic wellbeing.

As for Turkey’s politics, the ruling Justice and Development Party (AKP) and its leader President Recep Tayyip Erdoğan portray themselves as world giants. Their aggressive claims to that end are frequently heard across the arena of global politics and diplomacy. Despite these grand assertions, it is becoming clear that the country’s economy, which should provide a foundation for exerting global power and influence, is a mere paper tiger.

These days, even the most passionate supporters of the government are convinced that the Turkish business world and economy will not perform in the way their leaders claim it will. In response to the coronavirus outbreak, as many developed countries announced hundreds of billions of dollars in economic aid for businesses and consumers, the government in Turkey came up with a mere $15 billion in emergency funding by delaying a few taxes and offering to help banks restructure the debt of the corporate sector.

The AKP has been unable to provide voters with any concrete solutions aside from suggesting that they drop everything and self-quarantine to stop the spread of the virus. It has not offered them any alternative sources of income for staying home. Inevitably millions of Turks, forced to choose between going hungry or possibly contracting the virus, are reluctantly continuing to go to work. This has made Turkey a leader among countries experiencing the fastest-growing infection rates globally.

Even if Turks continue to go to work and miraculously remain largely virus-free, it is doubtful whether the economy can be rescued in the current global backdrop. This is because the country has a large outstanding foreign currency debt burden. According to Treasury data, the government and the private sector will have to pay back close to $70 billion over the next year. The country’s total gross reserves of foreign currency stand at less than $100 billion.

In the past 15 months, the central bank has intervened in the currency markets to prop up the lira, engaging in swap transactions with the nation’s state-run banks. When we subtract these swaps, its net foreign currency reserves, when subtracting liabilities, are almost depleted.

What comes next depends on the Turkish economy raising more foreign currency and spending less of it. But of course, considering that global demand for emerging market assets is plummeting and foreigners have cashed in their investments in Turkey at record rates in the past three months, this does not seem likely.

The fastest and most effective means for Turkey’s government to rescue the economy and stabilise the lira would be for it to make an agreement with the International Monetary Fund. This would entail significant political costs and it is unclear whether the Erdoğan government would be willing to pay the price. And it is important to remember that a fresh wave of U.S. sanctions against Turkey, enacted in response to its purchase of Russian S-400 missiles last year, showed that relations with the United States remain depressed. Little has changed since. This could impact very negatively on Turkey’s chances of getting IMF help even if it were to request it.

The outlook for the Turkish economy and the lira is therefore a very bleak one. Barring a miracle, the central bank may be forced to drop its support for the lira and leave it to float freely, with all the economic and social costs that may entail.