Turkish president Recep Tayyip Erdogan’s defence of recent interest rate cuts and declaration of an “economic war of independence” has sent the lira plunging and left analysts wondering how much further he is willing to let the currency fall.
Erdogan, who has sacked three central bank governors since mid-2019 and is a life-long opponent of high interest, has insisted that he will continue on the path of low rates in a quest to stimulate growth and investment. Forecasters including the IMF expect gross domestic product growth of 9 per cent this year — one of the fastest rates in the world.
But with the lira falling 15 per cent on Tuesday, analysts warn that the currency volatility could severely damp future growth. Erdogan’s approach, they say, carries serious risks for the health of the country’s financial system and the broader economy — as well as the prospect of growing public discontent. They see four main pressure points.
Will more Turkish savers switch to dollars?
Turkish banks allow customers to hold deposits in foreign currencies as well as in lira. In recent years, Turks have increasingly opted to keep their money in dollars and euros as high inflation and low interest rates have eroded returns on lira savings. Foreign currency deposits make up 55 per cent of all deposits in the country’s banking sector — around $260bn — compared with 49 per cent in 2018.
Analysts worry that dollar holdings could rise further, heaping more pressure on the lira and creating a vicious cycle.
Their ultimate fear is that people will lose trust and seek to withdraw their cash, which happened on a small scale during the last currency crisis in summer 2018. “My concern is from this point on: would you want to keep your money in the Turkish banking sector?” said Phoenix Kalen, an emerging markets strategist at Société Générale.
A full-blown run on the banks, when customers lose confidence and rush to withdraw their deposits, was last seen in Turkey in 2001. In such a scenario, the government could choose to impose capital controls, such as measures to make it harder to withdraw hard currency, although it has previously insisted it would not do so.
How high will prices go?
Soaring prices are already at the top of Turkey’s political agenda. Annual inflation stood at almost 20 per cent in October, according to the Turkish statistical institute. Food price inflation, which was more than 27 per cent year on year in the same month, has hit low income households especially hard.
Turkey’s reliance on imported goods, especially energy and raw materials, means a collapse in the currency translates quickly into higher prices. Jason Tuvey, of the consultancy Capital Economics, predicts inflation “is now likely to rise to 25 to 30 per cent over the next month or two”.
High inflation risks fuelling more currency weakness and stifling growth as consumer confidence is hit. It could also further undermine public support for Erdogan, whose two-decade rule was for years associated with rising prosperity. The opposition, which won control of the country’s two largest cities in municipal elections after the 2018 crisis, wants early elections so they can capitalise on growing disquiet over the economy.
The depleted net foreign exchange reserves of the central bank mean that its ability to intervene to defend the currency is limited. During previous bouts of lira weakness, including 2018, Turkey eventually announced emergency interest rate increases that halted the slide in the lira and tamed runaway inflation. But, in light of Erdogan’s tight grip on the central bank and his hints of more rate cuts, some analysts ask if this time is different.
The government appears to have “tolerance for a weakening lira”, said Enver Erkan, an analyst at the Istanbul-based Terra Investment, adding that it was hard to predict how far policymakers would be willing to let it fall.
Will banks retain access to foreign funding?
Banks in Turkey are heavily reliant on borrowing from abroad to fund their lending at home.
While foreign financing has remained resilient even in past episodes of extreme currency stress, such as in 2018, a sudden change in sentiment among foreign lenders could put the financial system under pressure.
“In recent years Turkey has gone through multiple crises and we’ve seen banks retain quite reasonable access,” said Huseyin Sevinc, who covers Turkish banks at the rating agency Fitch. Lenders had this year been successfully rolling over their syndicated loans from abroad, he added.
Banks “have significant foreign currency liquidity buffers to cover a brief market closure of around a year”, he said, but warned: “A prolonged market closure could carry significant risks.”
Can Ankara afford to pay its debts?
During the 2018 currency crisis, when the lira fell as much as 18.5 per cent in a single day after a row with the US ignited broader investor concerns about the economy, one of the biggest worries was the ability of the country’s heavily indebted corporate sector to pay back dollar and euro denominated loans.
Three years on, companies are in better shape, having deleveraged their external debt by $74bn, according to Barclays. Instead, some of that foreign debt has shifted to the public sector after the Treasury began issuing local debt denominated in foreign currency on the watch of former finance minister Berat Albayrak.
The FX component of central government debt reached 60 per cent of the total last month — up from 39 per cent in 2017. That means that as the currency slides it becomes more expensive for the Treasury to service its debt burden.
Turkey’s overall debt-to-GDP ratio is still low compared with that of its emerging market peers, at around 40 per cent of GDP. But analysts say the rising cost of debt servicing could limit the government’s fiscal space at a time when it is planning to increase giveaways as elections loom.
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