Mark Bentley
Feb 25 2018

Erdoğan is stuck with the dollar, like it or not

Turkish President Recep Tayyip Erdoğan, known for his increasing aversion for all things Western, appears to be developing a growing dislike for the dollar.

His senior economic adviser, Cemil Ertem, in comments to state-run television on Friday, warned Turkish viewers about the dangers of investing in the U.S. currency, saying that even a slew of rate hikes by the Federal Reserve would not arrest its decline in the medium term.

At the core of the dollar’s imminent demise were crypto-currencies, Ertem said. As a consequence, Turkey’s central bank would emulate countries such as Venezuela and its “Petro”, and work on the country’s own digital currency – the future of money exchange worldwide, he added.

Ertem comes from a new brand of policy advisers to Erdoğan – anti-Western, populist and quick to challenge conventional economic theories and the institutions that advocate them. At the same time, market-friendly figures such as Deputy Prime Minister Mehmet Şimşek, the successor to economy tsars Ali Babacan and Kemal Dervis, are seeing their influence over economic policy wane somewhat.

Erdoğan’s gradual turn from Western-inspired economic policy has coincided with the end of Turkey’s economic program with the International Monetary Fund in 2008 and his authoritarian stranglehold on Turkey’s system of government, which arguably gained momentum when German Chancellor Angela Merkel and then-French President Nicolas Sarkozy proposed a privileged partnership with Turkey instead of EU membership in 2009.

Rather than weigh up the pros and cons of IMF recommendations, advisers of Erdoğan such as Ertem now deride it as a tool of Western capitalism. IMF policies, backed by the dollar-based financial system, are designed to control developing countries such as Turkey by keeping them reliant on Western debt and hooked on imported goods, they maintain.

But, unfortunately, Erdoğan is stuck with the dollar for the foreseeable future. In fact, Ertem’s comments about the U.S. currency are wishful thinking when one studies Turkey’s economic realities.

Turkey trades in dollars, borrows in dollars and holds more of its foreign currency reserves in dollars than any other commodity. The country’s widening current account deficit, fueled by reliance on imported oil and natural gas -- Turkey has virtually no reserves of its own – and imported raw materials, which are largely denominated in dollars, means that inflows of dollars and other major currencies, in the form of direct investment and purchases of stocks and bonds, support rather than erode the value of the Turkish lira.

Still, the lira has hardly performed well in recent years. Just prior to the eruption of the financial crisis in 2008, Turkey’s currency traded at 1.15 to the dollar. The rate is now around 3.8, a loss of approximately 70 percent.

Tim Ash, senior emerging markets strategist at hedge fund BlueBay Asset Management in London, said Ertem’s comments, although directed at a domestic audience, don’t send a particularly positive message to foreign investors.

“It does damage Turkey’s reputation externally. There are decent people in the administration still, but their market-friendly and investor-friendly messages are undermined by people like this.”

And, contrary to what Erdoğan and Ertem may wish for, Turks love to save in dollars because it gives them protection against the depreciation of the lira and the erosive effect on their earnings of consumer price inflation, currently around 11 percent, the highest in major emerging market economies.

Since the financial crisis, savings in foreign exchange have doubled to about $158 billion.

Foreign exchange savings of Turkish residents

Recent political tensions with the United States, spurred on by U.S. support for Kurdish militants in Syria and the threat of financial penalties against Turkey after a deputy CEO of a state-run bank was found guilty by a U.S. jury of evading sanctions on Iran, mean dollar savings in the country are once again on the rise.

Turks last turned to the dollar in such great numbers in the months following the global financial crisis and again from mid-2013 to late 2014. The lira lost almost 30 percent of its value during the latter period, partly because of a corruption scandal surrounding Erdoğan’s government that erupted in December 2013.

Prior to the financial crisis, the dollar had boosted Erdoğan's popularity. It was the lira’s losses against the U.S. currency in 1999-2001 that helped carry him and his Justice and Development Party to power at elections in late 2002. It was also the dollar that provided Erdoğan and his country with the finances to increase spending and economic growth during the following decade, thanks to IMF-backed reforms and Turkey’s accession process with the EU. The lira rallied as a consequence.

Just like its consumers, Turkey’s companies are hooked on the dollar. With double-digit inflation rates in Turkey, it is very costly for firms to borrow in lira. Interest rates on commercial loans averaged about 15.2 percent at the end of last year.

Consequently, Turkish CEOs have turned to borrowing in dollars and euros. However, while interest rates on the loans are much lower, such borrowing leaves them exposed to currency risk, particularly if they earn the majority of their revenue in liras and the currency’s value declines.

As central bank data shows, non-financial companies in Turkey now have more than $200 billion in foreign exchange liabilities that are not covered by equivalent assets, a record high. That deficit was about $50 billion 10 years ago.

central bank graph
Source: Turkish central bank

Consequently, Erdoğan’s government introduced restrictions on the borrowing late last year, barring some firms from taking out loans in dollars and euros.

Returning to Ertem’s proposal that Turkey introduce its own crypto-currency, in November the central bank praised crypto-currencies for their ability to enhance financial stability. Turkish press reports now suggest that the authorities may approve the introduction of a crypto-currency called the “Turkcoin”.

But the idea of nation states creating their own crypto-currencies is a controversial one.

While buying, selling and use of cryptocurrencies is not illegal in Turkey, the influential Directorate of Religious Affairs has expressed opposition, declaring such commodities incompatible with Islam and expressing concern that they could be used as a vessel for illegal activities.

In January, Venezuelan President Nicolas Maduro touted the Petro as a means for Venezuela to increase access to financial markets, in effect circumventing U.S. sanctions on the country. Venezuela raised $735 million in an initial sale of the coins last week, according to its government.

On Jan. 5, the U.S. Treasury Department imposed sanctions on four current or former Venezuelan generals for their involvement in corruption and acts of political repression. The decision was part of an ongoing campaign against the human rights abuses and alleged systematic corruption of Maduro’s regime, it said.

Washington-based think tank the Foundation for Defense of Democracy (FDD) is so concerned about the potential misuse of crypto-currencies by nation states that it has commissioned a special study to better understand how the Petro could help Maduro further undermine democracy.

Michaela Frai, a research associate for FDD’s Latin America project, who is now helping manage the Petro-focused investigation, told crypto-currency news service, CoinDesk, last week that she was concerned that the currency's introduction “is going to continue to perpetuate this fake democracy, and only support the authoritarian dictatorship.”