Türkiye’s lira weakens as economists warn of economic challenge

Turkey’s lira weakened after the re-election of Recep Tayyip Erdogan, as analysts warned that the next big test for the victorious president would be addressing the country’s shaky $900bn economy.

Many economists argue that Erdogan’s policies of low interest rates and emergency measures to prop up the currency cannot continue. The lira hovered near a record low on Monday after surpassing TL20 against the US dollar late last week.

“The current policy stance has become untenable,” said Liam Peach at Capital Economics in London. “Turkey cannot continue for too long with very low interest rates, very loose fiscal policy and all kinds of foreign exchange reserves.”

Turkey’s reserves have declined by about $27 billion this year as the country attempts to prop up the lira and finance a record current account deficit.

Official data puts the reserves, including foreign exchange and gold, at slightly above $101bn.

However, net reserves, a figure that separates liabilities, is zero and deeply negative in effect, according to JPMorgan, excluding tens of billions of dollars of money borrowed from the local banking system.

Clemens Graff, an economist at Goldman Sachs in London, said reserves were now “closer to the level when the lira’s volatility increased sharply earlier”.

But shortly after securing his victory in Sunday’s run-off vote with 52 percent of the vote, Erdogan insisted he would maintain his low-interest rate policy, even though inflation is currently above 40 percent.

He said, ‘If someone can do it, I can too. “(The central bank’s key interest rate) has now been reduced to 8.5 per cent and you will see that inflation will also come down.”

He said that “redressing the problems of price rise and loss of welfare due to inflation is the most pressing issue of the coming days” – but did not give any details.

Investors are also concerned about the equivalent of $121bn that Turks have put into special savings accounts, to be paid at the government’s expense if the lira depreciates.

The measure has slowed the rate at which Turks are buying foreign currency, but Finance Minister Noordin Nebati said the accounts were worth about TL95.3bn ($4.7bn) in 2021 since they were introduced.

If the lira depreciates sharply in the coming weeks, the impact on public finances could intensify.

However, Erdogan may be able to tap fresh funding from allies in the Middle East and Russia, analysts say.

The president said last week that unnamed Gulf countries had contributed funds to help stabilize Turkey’s markets, but did not elaborate.

Wolf Piccoli at Teneo Consultancy said Erdogan would likely get a short-term boost from summer tourist cash receipts, which ease pressure on the country’s finances.

Turkey’s Bist 100 stock index, which has been boosted by locals seeking refuge from high inflation, also jumped more than 4 percent on Monday.

Some economists say Erdogan may appoint a new economic team that could bring back familiar names to foreign investors.

“With the election round the corner, all eyes will be on the composition of the economic team and the credibility of the initial policy response,” said Ilkar Domecq at Citigroup.

But Domak also warned that it will be “increasingly challenging” for Turkey’s central bank to keep interest rates well below inflation “especially during the last quarter of the year and thereafter”.

Other economists indicated a greater degree of danger.

“Be prepared for a worst-case scenario, which could require formal capital controls or severe deposit flight from the banking system,” wrote Attila Yesilada at GlobalSource Partners consultancy in Istanbul.

Turkey’s lira weakened after the re-election of Recep Tayyip Erdogan, as analysts warned that the next big test for the victorious president would be addressing the country’s shaky $900bn economy.

Many economists argue that Erdogan’s policies of low interest rates and emergency measures to prop up the currency cannot continue. The lira hovered near a record low on Monday after surpassing TL20 against the US dollar late last week.

“The current policy stance has become untenable,” said Liam Peach at Capital Economics in London. “Turkey cannot continue for too long with very low interest rates, very loose fiscal policy and all kinds of foreign exchange reserves.”

Turkey’s reserves have declined by about $27 billion this year as the country attempts to prop up the lira and finance a record current account deficit.

Official data puts the reserves, including foreign exchange and gold, at slightly above $101bn.

However, net reserves, a figure that separates liabilities, is zero and deeply negative in effect, according to JPMorgan, excluding tens of billions of dollars of money borrowed from the local banking system.

Clemens Graff, an economist at Goldman Sachs in London, said reserves were now “closer to the level when the lira’s volatility increased sharply earlier”.

But shortly after securing his victory in Sunday’s run-off vote with 52 percent of the vote, Erdogan insisted he would maintain his low-interest rate policy, even though inflation is currently above 40 percent.

He said, ‘If someone can do it, I can too. “(The central bank’s key interest rate) has now been reduced to 8.5 per cent and you will see that inflation will also come down.”

He said that “redressing the problems of price rise and loss of welfare due to inflation is the most pressing issue of the coming days” – but did not give any details.

Investors are also concerned about the equivalent of $121bn that Turks have put into special savings accounts, to be paid at the government’s expense if the lira depreciates.

The measure has slowed the rate at which Turks are buying foreign currency, but Finance Minister Noordin Nebati said the accounts were worth about TL95.3bn ($4.7bn) in 2021 since they were introduced.

If the lira depreciates sharply in the coming weeks, the impact on public finances could intensify.

However, Erdogan may be able to tap fresh funding from allies in the Middle East and Russia, analysts say.

The president said last week that unnamed Gulf countries had contributed funds to help stabilize Turkey’s markets, but did not elaborate.

Wolf Piccoli at Teneo Consultancy said Erdogan would likely get a short-term boost from summer tourist cash receipts, which ease pressure on the country’s finances.

Turkey’s Bist 100 stock index, which has been boosted by locals seeking refuge from high inflation, also jumped more than 4 percent on Monday.

Some economists say Erdogan may appoint a new economic team that could bring back familiar names to foreign investors.

“With the election round the corner, all eyes will be on the composition of the economic team and the credibility of the initial policy response,” said Ilkar Domecq at Citigroup.

But Domak also warned that it will be “increasingly challenging” for Turkey’s central bank to keep interest rates well below inflation “especially during the last quarter of the year and thereafter”.

Other economists indicated a greater degree of danger.

“Be prepared for a worst-case scenario, which could require formal capital controls or severe deposit flight from the banking system,” wrote Attila Yesilada at GlobalSource Partners consultancy in Istanbul.