Lira flash crash: Erdoğan double-down leaves Turkey exposed

Turkey’s vulnerability to shifts in investor sentiment – and a possible repeat of last year’s currency crisis -- was exposed on Monday when Japanese investors sold the lira in droves, leading to a flash crash that briefly sent the currency down by 10 percent against the dollar.

The lira later recovered most of its losses to end the day down 1.2 percent at 5.8296 per dollar, but the flash crash – the second this year – points to growing concern over the direction of economic policy under President Recep Tayyip Erdoğan.

Since gaining vast new powers at presidential elections last June, Erdoğan is doing what strongmen typically do to stave off challenges to their power – doubling down. But this questionable approach, which he employs in foreign relations and to bolster his popularity at home, is slowly but surely threatening the outlook for Turkey’s embattled lira and economy.

Erdoğan has upped the political ante in a recent international crisis over gas exploration in the eastern Mediterranean, his ousting last week of three Kurdish mayors, and in a crisis with the United States over his purchase of Russian S-400 missiles. He has also doubled down when it comes to the economy, employing s swift succession of short-term measures to solve Turkey’s economic ills.

However, each time Erdoğan makes use of such tools, the repercussions become incrementally greater to bear, for his government and for him personally.

Erdoğan’s relentless crackdown on dissent at home has increased his dominance over almost every political institution in the country. But it has also carried a political cost. It contributed to defeats in local elections this year – his ruling party lost control of Istanbul and the capital Ankara -- and to the spawning of rival political movements by his former allies, such as ex-Deputy Prime Minister Ali Babacan.

His doubling down on rhetoric against the United States, the European Union and Greece is also proving more and more costly. Relations with the European Union – Turkey was a promising candidate for membership just a decade ago – have become virtually irreparable. Holding the EU hostage to a Syrian refugee agreement, signed in 2016, has only poured fuel on the fire.

Turkey paid a heavy price when Erdoğan cranked up a political crisis with the United States last year, first by carrying out a threat to invade Syria then by refusing to release a U.S. pastor from detention. Economic sanctions were the result. The lira tanked to an all-time low and an economic recession ensued.

Incrementally increasing the number of ships exploring for natural gas near ethnically-divided Cyprus this year has not only caused severe damage to relations with the European Union and neighbouring Greece, but it has also excluded Turkey from an emerging alliance in energy cooperation between Israel, Egypt, Greece, Cyprus and the United States. Brussels is now threatening its own economic sanctions in retaliation.

Erdoğan’s questionable tactics, however, appear to have caused the most damage to Turkey’s economy.

The Turkish president’s power grab at home means he has become the country’s sole economic decision-maker.

International ratings agencies have downgraded the country’s debt as Erdoğan’s increasingly centralised approach meant that economic policy became more and more difficult to predict. Perhaps most notably, Erdoğan merged the Treasury and Finance Ministry last summer and appointed his son-in-law Berat Albayrak, an economic policy novice, to head both institutions.

berat albayrak
Erdoğan with his son-in-law, Treasury and Finance Minister Berat Albayrak

Erdoğan has also doubled down in fiscal policy. The lira tanked last August partly because his government introduced a raft of loan schemes and tax cuts to stimulate the economy. His response to the currency crisis was to increase the frequency and ad-hoc nature of those populist measures.

The same process can be seen in monetary policy. Early this decade, Erdoğan’s aversion to interest rates – grounded in his Islamic past -- prompted the central bank to introduce a bewildering array of monetary tools to placate him and at the same time attempt to control inflation and protect the lira. Unsatisfied, Erdoğan sought to undermine the central bank’s approach by offering lending from state-run banks at interest rates below its key policy rates.

Rather than give at least private backing to the central bank as it sought to defend the lira during last year’s currency crisis by increasing borrowing costs, Erdoğan publicly scolded it, repeating his theory that higher rates stoke inflation rather than reduce it. When the lira stabilised and inflation began to slow markedly from a 15-year high of 25.2 percent in October, he remained silent, quietly seething.

In the March local elections, Erdoğan lost Turkey’s major cities of Ankara and Istanbul despite an avalanche of tax cuts, loan incentives and other populist measures. Threats to sack several Kurdish mayors, eventually carried out last week, failed to stop pro-Kurdish candidates from taking several major cities in the southeast of the country.

Opinion polls carried out after the elections painted a grim picture for the president. They showed that voters were increasingly distrustful of his management of the economy. Some traditional supporters of his ruling Justice and Development Party (AKP) – transformed from a coalition of liberals and religious conservatives into his own personal policy machine -- either failed to show up at polling stations or voted for rival candidates.

Since a second defeat in an election for Istanbul mayor in June (Erdoğan refused to accept the first result) he doubled down again.

After courting U.S. President Donald Trump to temporarily stave off a new set of economic sanctions – this time for his purchase of Russian S-400 air defence missiles -- Erdoğan set about blaming the central bank’s governor for his election defeat, sacking him and replacing him with a more “trustworthy” figure.

Since last month’s dismissal of Murat Çetinkaya – and threats of more layoffs -- the central bank has slashed interest rates by 425 basis points to 19.75 percent. Borrowing costs had stood at 24 percent since October. All pretence of central bank independence, enshrined in an IMF programme in the early 2000s, was lost with Çetinkaya’s sacking.

Meanwhile, as Turkey’s budget deficit widened relentlessly to approach a year-end target with only six months gone, Erdoğan extracted tens of billions of liras from the central bank for the second time this year. The cash, an emergency fund, was funnelled straight into Treasury coffers to continue the government’s spending spree.

Now Turkey’s leader is insisting that the central bank cut interest rates again at a meeting in September, warning that further disloyalty to the government and its policies would lead to further dismissals.

In the meantime, Erdoğan has instructed state-run banks to turn the borrowing taps on full. They have complied, slashing interest rates on mortgages, consumer and business loans by up to one third. The central bank also supported the move this month by telling banks that they can deposit less money in mandatory reserves should they lend more to businesses and consumers.

Erdoğan has also sought to consolidate his economic policies by increasing the powers of the Treasury and Finance Ministry. He signed a presidential decree this month allowing the ministry to take stakes in private companies. The decision has prompted Erdoğan’s political opponents to claim that he will use public money to rescue government-friendly businessmen.   

Barring an unlikely reversal in policy direction, the outlook for Turkey’s economy is set to deteriorate.

Investors, hopeful that Ankara would return to prudent economic policies following the hotly contested local elections, are having more and more difficulty predicting Erdoğan’s next move. Their bets on hope – based on the pro-IMF policies his government followed a decade ago -- have now turned into realism and loss limitation.

An intensifying trade war between the United States and China may have helped spark Monday’s flash crash in Asia -- Washington and Beijing exchanged tit-for-tat tariffs on Friday. But it shows that Turkey, along with crisis-hit Argentina, is again first in the firing line when global sentiment turns sour.

Should Erdoğan continue to double down on the economy and to strengthen his hold over Turkey, it will be ordinary Turks who suffer in terms of eroding spending power and lost opportunity. Eventually, the economic and political consequences will reach the gates of the presidential palace itself. Without a backward step, the rest could be history.   

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