The chain of mistakes that led the lira to record lows

In Turkey, the government is learning no lessons from its failures in running the economy. Cause-effect relations and the basic rules by which money markets function are completely clear in the global capitalist system that Turkey is a part of. Even the economic carnage wrought by the COVID-19 coronavirus has not changed this.

Yet when faced with economic problems, the first reaction of Turkey’s government is to deny their existence. This is followed by utterly unconvincing measures, apparently taken recklessly and without heeding economic dynamics, that only exacerbate the damage to the country’s economy.

It would probably take a psychologist to explain the extent that this administration is removed from reality. But it bears repeating that the lira’s slide to an all-time low of 7.269 per dollar on Thursday is not, as the government claims, the work of remorseless foreign investors, and the problems that brought it to this point cannot be solved by stoking nationalism.

The road leading to the lira’s losses is marked by a completely different series of milestones to those quoted by government officials.

Turkey has approached the U.S. Federal Reserve and other central banks in hopes of securing swap lines to reduce the pressure after its own central bank depleted its foreign currency reserves mounting a defence of the lira. But while it was still knocking on foreign central banks’ doors on Thursday, it banned Citibank, UBS and BNP Paribas, three of the world’s main currency traders, from trading in liras, saying they had failed to pay their lira liabilities on time.

The aim, of course, was to prevent currency traders from making money short selling liras while the macroeconomic data showed that the currency was defenceless.

Turkish banks are known to be extremely active in trying to hand out large credit lines in currency markets. But last year, as the lira began a precipitous slide ahead of crucial local elections in March, the Turkish authorities intervened to prevent the banks from loaning any liras to foreign traders, sending the borrowing costs soaring overnight in the offshore market to more than 1,000 percent.

At the time, Treasury and Finance Minister Berat Albayrak said the government was hitting back at speculators to strengthen the lira, warning that those who expected the currency to fall below 7 per dollar would have their fingers burnt.

But this intervention was, naturally, a turning point for the currency that drowned out foreign investment in the swap market. It triggered a hasty withdrawal of foreign capital as investors drew away from Turkey out of fear of an economy that was no longer governed by rules. The many economists who warned of the mid-to-long term impact of this move were ignored by the government, which instead marked them out as agents of foreign powers or the so-called interest rate lobby.

Since then, President Recep Tayyip Erdoğan’s government has been pursuing economic growth as a main priority, but with foreign capital keeping its distance, it has been forced to look to public funds to finance that growth. This led it to transfer a large portion of the central bank’s reserve funds to the Treasury and doubled the budget deficit-to-GDP ratio in two years.

As Turkey failed to attract foreign investment and the lira’s value headed downwards, the country ended up with a de facto managed float system, with the central bank and public banks trading foreign currencies to hold the lira at around 5.5 per dollar. This operation was widely reported by foreign press outlets and economists, though central bank governor Murat Uysal still chose to deny it as recently as last week.

Counting its defence of an increasingly fragile lira as a victory, the government hastened its pursuit of growth by having Uysal slash the benchmark rate at the last eight central bank meetings. While the early cuts to the interest rate, which had peaked at 24 percent in 2018 due to a currency crisis, were welcomed, the rapid fall to the current 8.75 percent rate, below the country’s 10.9 percent inflation, has begun to have a backlash on the lira.

And, just as growth returned to the economy after a technical recession in the final quarter of 2018 and economists were foreseeing another wave of currency weakness perhaps in the next year or two, the coronavirus pandemic struck.

Some $100 billion in funds from foreign markets has flown out of Turkey this year, and with its net reserves at negative levels, the central bank is unable to mount a defence of the lira.

The Turkish economy is now entering a deep spiral of unemployment and contraction, foreign funds are not forthcoming and the lira hit record lows on Thursday before a limited rally on Friday.

But instead of accepting its mistakes leading to these dire straits, the government is once again attempting to push the claim that Turkey is under attack – to the extent that the banking watchdog has laid the foundation for legal action to be taken against economists who comment on the lira or publish data-backed commentary criticising the decisions leading to its fall.

Nevertheless, the reasons for the lira’s losses, as we have just seen, are as clear as day, and there is not need for much further analysis. The economy is being managed very poorly by officials who are not qualified to run it.

The opinions expressed in this column are those of the author and do not necessarily reflect those of Ahval.