Guldem Atabay
Mar 25 2019

Lira’s losses signal new bout of troubles for the Turkish economy

The Turkish lira is again leading a list of emerging market currencies that stumbled last week, posting more than 4 percent of losses in a single day on Friday.

A chain of events that extends from the economy to politics is weighing on the currency. More volatility is likely in store for the months ahead.

But the Turkish government is burying itself in more conspiracy theories to explain the lira’s slide.

Just a few days ago, Treasury and Finance Minister Berat Albayrak mocked those who were setting aside hard currency as protection against inflation of almost 20 percent, claiming that the lira would gain ground and those who bought dollars would lose out for not trusting the government. Within a week, the lira started weakening sharply, again.

News over the weekend that the banking regulator and capital markets board launched separate investigations into U.S. investment bank JPMorgan shocked investors. Whether or not the investigation leads to formal punishment, it is a very dangerous move. The probes are likely to lead to a further run on the lira as accusations that JPMorgan somehow manipulated the market are based on a routine macro-economic report containing a call to short the lira. JPMorgan’s reasoning was based on several political and economic factors.

The behaviour of Turkish authorities reflects just how far detached the government has become from the economic realities ahead of nationwide local elections on Sunday at which the ruling Justice and Development Party (AKP) could lose control of several cities, including perhaps the capital Ankara.

Looking beyond the March 31 vote, there are rational and concrete reasons for the lira sell-off to continue despite the tail winds coming from a more dovish U.S. Federal Reserve.

Turkey’s insistence on purchasing S-400 missile defence systems from Russia, which runs against NATO policies, has been reverberating quietly in financial markets over the past couple of weeks. Statements by high-ranking U.S. and Turkish officials are causing investors and the Turkish public to believe that there is a possibility of renewed U.S. economic sanctions against Turkey.

President Recep Tayyip Erdoğan’s reaction to President Donald Trump’s announcement on the Golan Heights last week was received badly by Washington, given the already tense U.S.-Turkey relationship. Erdoğan’s partisan tone added to the negative sentiment.

U.S. sanctions introduced last August over Turkey’s detention of an American pastor proved a tipping point for lira. In two weeks, the lira slid to 7 per dollar from around 4.7, sending shock waves through the economy. The similar tensions now surfacing are of course prompting investors to shy away from Turkey. Foreign investors are more inclined to sell lira, while locals increase their hard currency deposits fearing a repeat of last year’s currency meltdown.

The central bank’s decision on Friday to halt its main method of lira financing – it previously sold benchmark one-week repo in weekly auctions at 24 percent – is designed to create demand for lira. The bank took the decision after data showed its net foreign exchange reserves fell $6.3 billion to $28.5 billion in just two weeks. But the move failed to impact the lira’s slide. In fact, the central bank’s inadequate explanations for the level of its reserves just added to market unease.

The government’s increasingly opaque way of managing the economy, including seemingly directing the activities of supposedly autonomous state agencies like the banking watchdog and capital markets board is causing further unease in the markets. As is the control the government is imparting over the lending policies of state-run banks. This behaviour is also stoking fears that the central bank will cut rates prematurely under political pressure after the elections, despite its cautious statements on inflation.

There are also solid economic reasons to support the lira’s weakness. The economy’s main problem is the foreign exchange debt of corporates and the banking sector. This continues to spur demand for hard currency.

As of January, Turkey’s short-term external debt stock was $118 billion, an increase of 1.5 percent compared to the end of 2018. The short-term external debt stock of banks increased by 1.4 percent to $57.7 billion, while that of other sectors grew 1.7 percent to $54.4 billion. The short-term debt of the public sector increased 8.7 percent to $24.4 billion because the government has front-loaded borrowing on the international markets this year to help cap domestic interest rates.

turkey central bank

With such heavy debt obligations, equal to roughly 20 percent of Turkey’s GDP, becoming due over the next 12 months and Turkey’s external deficit, which is being financed through inflows of capital from unknown sources, the lira’s weakness should not be a surprise to anyone. This should be especially true for the government, which based Turkey’s GDP growth during the past decade on cheap external borrowing. The loans were bound to get costlier when the days of easy money, created by monetary easing by the Federal Reserve and then European Central Bank, came to an end. And that is exactly what has been happening since May 2013, a phenomenon that gained pace between December 2015 and January this year.

Thus, the argument that the Turkish economy is being attacked through selling lira is just cheap talk, as is the government’s argument that the country’s economic ills are being caused by foreign enemies plotting against the ruling party. Economic facts tell the real story. There is a shortage of external funds and a need for rational/transparent economic management. Turkey’s economy is destined to grow at a slower pace in the coming years unless things change. The longer it takes for these facts to be digested and acted upon by the AKP government, the worse things will get.