Turkey remains under heavy fire on the markets in what is fast developing into a stand-off between investors and President Recep Tayyip Erdogan. After years of strong growth and inflation at 16 per cent – and heading higher – investors fear the economy is heading for a hard landing and are selling the Turkish lira. But Erdogan has set his face against one obvious solution – higher interest rates – and so far the Turkish authorities have been a step behind the game in trying to get to grips with the crisis.
And of course this is about more than economics. Simmering tensions between the US and Turkey have escalated due to the Turkish detention of a US pastor,who is on trial for espionage and terror-related charges related to the attempted coup against Erdogan in 2016. In response president Trump increased tariffs on Turkish steel and aluminium exports to the US on Friday. Adding fuel to the fire is Turkey’s refusal to cooperate with Trump’s Iranian sanctions and its increasing links with Russia, from where it recently ordered new defence missiles.
Reliance on foreign funding
As a country with a large current account deficit – over 5 per cent of GDP – and a reliance by its banks on foreign funding, Turkey needs foreign cash and is thus vulnerable. The lira sell-off has been intense and in turn this raises doubts about the sustainability of borrowings in US dollars by Turkish businesses and the funding of the financial system and the State.
The warning lights are flashing. The currency is now down spo,e 40 per cent against the US dollar this year , with half of this loss over the past week or so. Turkey’s ten year bond interest rates are over 20 per cent. A perception that Erdogan, who recently took on new powers in his “executive presidency”is controlling the economy is causing further damage – his son-in-law is finance minister and the central bank has been told by the president not to increase interest rates.Erdogan’s assurances that “ Turkey has strong economic fundamentals and it will continue being robust” are dismissed as a typical political response to such events.
In response to the crisis, the Turkish central bank tweaked some of its banking rules on Monday morning , to try to free up more liquidity into the system. Some reports also suggest that it have increased the cost of borrowings to the banks Some new government measures to help the real economy are also promised.
But investors are looking for a much more robust response than seen to date, fearing that the Turkish economy, fuelled with foreign credit for years, may be heading for a crash, with particular vulnerabilities in areas like construction and the real estate sector. As US interest rates rise, US cash is now looking to invest more at home, leading to a new focus on those countries and businesses that took on foreign borrowings when rates were on the floor.
Contagion risks
The lira crisis has led to some weakness in international markets and in particular has hit currencies in emerging markets like South Africa, where there are also fears that US dollar borrowings may have left exposures. European banks who hold Turkish assets or lira have also seen share prices falling and generally the uncertainties have meant a knock for international share prices.
One interesting fall out has been selling of the euro, due to fears of some exposure to a big country on the EU’s borders. As a result, the euro is at its lowest level this year against the US dollar – below $1.14. A weak euro has also led to sterling trading higher, around 89.21p, having gone over 90p last week.
It remains to be seen how possible selling pressure on both sterling and the euro balance out in this key exchange rate for Ireland. For the moment, the US dollar, the yen and the Swiss franc are the currencies in demand.
Where does this go next? There is no sign of the pressure easing, leaving Turkey with limited options, all currently being ruled out by the President. A significant rise in interest rates, current 17.75 per cent, could help underpin the lira, but only if accompanied by a wider economic programme. Turkey has said it will not impose capital controls – limiting movements of currency in and out of the country. In any event these are only ever temporary solutions in financial emergencies. And Turkey has also said it will not seek help from the IMF. A programme to slow runaway growth – including higher taxes and lower government spending – would also be welcomed by investors.
Erdogan has said the country is in an economic war and called on the population to sell dollars and buy lira. His administration has also pointed to social media and plots against the country and Erdogan has pointed the finger at what he calls “traitors” spreading false rumours.
But rhetoric is not going to get him anywhere. And the problem for Turkey now is that market confidence, once lost, is hard to regain. As we have seen over and over again, once a crisis builds, the banking system can quickly run into liquidity problems, investors will stop lending to the country and its financial system and then it is a long way back.
