Turkey’s lira weakens as economists warn of ‘unsustainable’ policies

Turkey’s lira weakened in the wake of Recep Tayyip Erdoğan’s re-election, as analysts warned that the next big test for the victorious president would be to address the country’s unstable $900 billion economy.

Many economists argue that Erdoğan’s policy of low interest rates and emergency measures to prop up the currency cannot continue as Turkey’s stockpile of foreign exchange reserves is rapidly dwindling.

The lira fell 0.6 percent to a near-record low of 20.2 against the U.S. dollar as trading resumed in London, the primary hub for European currency trading, on Tuesday after a bank holiday.

“The current policy stance has become unsustainable,”[ads1]; said Liam Peach at Capital Economics in London. “Turkey cannot continue with very low interest rates, very loose fiscal policy and burning through all kinds of foreign exchange reserves much longer.”

Turkey’s reserves have fallen by about $27 billion this year as it has tried to prop up the lira and finance a near-record current account deficit.

Line chart of lira per US dollar showing Turkish lira weakening after Erdoğan's re-election

Official data put the reserves, including foreign currency and gold, at just over $101 billion.

However, net reserves, a figure that strips out liabilities, is effectively zero, and deeply negative when you exclude the tens of billions of dollars in money borrowed from the local banking system, according to JPMorgan.

Clemens Grafe, an economist at Goldman Sachs in London, said reserves were now “close to levels when earlier lira volatility increased sharply”.

But immediately after securing victory in Sunday’s vote with 52 percent, Erdoğan insisted he would maintain the low interest rate policy, even though inflation is currently above 40 percent.

“If anyone can do this, I can do it,” he said. “[The central bank’s main interest rate] is now reduced to 8.5 percent, and you will see that inflation will also fall.”

He added that “eliminating the problems of price increases caused by inflation and the loss of welfare are the most pressing issues in the coming days”, but gave no details.

Billion dollar line chart showing Turkey's current account deficit is close to the widest on record

Investors are also worried about the equivalent of $121 billion that Turks have deposited in special savings accounts that pay out at the expense of the government if the lira falls.

The move has slowed the rate at which Turks have been buying foreign currency, but Nureddin Nebati, the finance minister, said the accounts had cost the country about 95.3 billion TL ($4.7 billion) since they were introduced in 2021.

The blow to public finances could increase rapidly if the lira falls faster in the coming weeks.

Still, Erdoğan may be able to draw on new funding from allies in the Middle East and Russia, analysts maintain.

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

Billion dollar line chart showing Turks rushing to hide their money in currency-hedged savings accounts

Erdoğan is likely to get a short-term boost from summer tourist cash that tends to ease the strain on the country’s economy, said Wolf Piccoli of the Teneo consultancy.

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. It has generally been lifted by high inflation as local investors seek opportunities for returns that can compete with rapid consumer price growth.

Some economists say Erdoğan may appoint a new economic team, bringing back names well known to foreign investors.

“With the election behind us, all eyes will be on the composition of the economic team and the credibility of the initial policy response,” said Ilker Domac at Citigroup.

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

Other economists signaled a greater degree of alarm.

“Be prepared for the worst, which could involve formal capital controls or severe flight of deposits from the banking system,” wrote Atilla Yesilada of Istanbul-based consultancy GlobalSource Partners.

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