Turks turn to foreign currency and gold as lira slumps, inflation spikes

Turkish Treasury and Finance Minister Berat Albayrak says the lira’s plunge against the dollar creates a competitive currency and economy. But Turkey’s foreign trade data for August tells a different story.

The erosion of trust among Turks in the economic management of Albayrak, who is the son-in-law of President Recep Tayyip Erdoğan, is reflected in an extraordinary increase in foreign currency and gold deposits in the country.

Turkey’s trade deficit soared in August as purchases of gold from abroad jumped almost four-fold to $4.1 billion, the highest level since 1989.

Turks appeared to be scrambling to purchase gold after the lira dropped to a record low against major currencies last month. It has extended those historic lows in September.

The gold buying spree helped imports increase by an annual 21 percent to $18.8 billion, widening the trade deficit by 170 percent to $6.31 billion.

Concerns for the management of the economy, focused on defending the lira while creating a borrowing boom through keeping interest rates at below the rate of inflation, are being exacerbated by a slump in tourism revenue, a critical source of hard currency.

The European Union, much to Ankara’s annoyance, is keeping Turkey off its safe travel list, meaning income for the tourism industry will be a fraction of the record $34.5 billion earned last year.

While losses for the lira might have increased the price competitiveness of Turkish exports, this did not translate into an increase in sales of goods abroad. Quite the contrary.

The trade deficit in August meant the gap for the first eight months of the year stood at $32.9 billion, an increase of 69 percent compared with the same period of 2019. Exports fell by 13 percent while imports declined 1.1 percent.

Turkish Industry and Business Association (TÜSİAD) Chairman Simone Kaslowski told Dünya newspaper last week that Albayrak’s competitive currency narrative was “outdated”.

“Competition cannot be achieved by currency rates at this point,” he said. “but through quality and efficiency – for which you need an educated workforce and technology.”

Companies need to innovate and achieve competitive advantage through investments, the industry leader said. But lira instability reduces the desire of companies to invest and increases the cost of raw materials and intermediate goods, Kaslowski said.  

“The latest pandemic has shown that it is not enough to be cheap to remain in the supply chain,” he said.

Turkey’s Statistics Institute (TÜİK) also announced August inflation data last week, saying annual price increases remained little changed at 11.77 percent. But nobody seemed convinced that the data was accurate. Now there is virtually no chance that year-end inflation will slow to single digits, meaning that the government and central bank’s estimates will be missed.

Core inflation, which helps the central bank draw up its official inflation forecast, accelerated to beyond 11 percent, while the domestic producer price index rose to 11.53 percent from 8.33 percent, suggesting that consumer price inflation will accelerate again in September.

The impact of the lira’s declines in late August were not reflected in consumer price inflation data, but the effect on producer prices, more immediately sensitive to fluctuations in the currency’s value, was very evident, accounting for almost one-third of the increase.

In September, consumer price inflation will also be hit by a hike in the special consumption tax on cars, a change made by presidential decree on Aug. 30. This measure came too late to affect the August inflation numbers so will hit inflation in September.

A similar slump in the lira in August 2018, when the United States imposed sanctions on Turkey for its detention of U.S. Pastor Andrew Brunson, hit inflation hard in September of the same year. The Central Bank was forced to raise interest rates significantly, eventually boosting the benchmark rate to 24 percent.

Now Turkey’s economic management team finds itself in the same corner, but the Central Bank has kept the benchmark interest rate stable at 8.25 percent for the last four months after slashing it from 24 percent, a level it has stood at until July last year. Instead, the bank has tweaked other lending rates, meaning the weighted average cost of funding stands at just over 10 percent.

Because of the central bank’s reluctance to raise interest rates sharply to curb inflation – Erdoğan opposes higher rates saying they are inflationary - lira investments are no longer attractive because they barely compensate for the erosive effects of inflation. Turks have hence sold the lira for foreign currencies and gold.

Domestic resident foreign currency accounts rose $604 million in the last week of August to $217.9 billion. The increase in gold accounts was $599 million, bringing the total in gold to $32.8 billion, constituting a 261 percent rise in monetary value compared to the same month of last year.