What or who will save the Turkish lira?
The fatal policy mistakes committed by the Turkish government between 2018 and 2020, which caused two massive currency sell-offs in two years, continue to reverberate in the economy. The first quarter of 2021 is not even over, but losses for the embattled lira are already reaching eye-catching proportions.
After falling to as low as 7.79 per dollar last week, the weakest level since December, the value of the lira has been fluctuating in a volatile fashion around 7.5 against the U.S. currency. The lira’s vulnerabilities have been laid bare by deteriorating expectations for global inflation and a selling spree in U.S. bonds.
An increase in world commodity prices and rising oil prices are invigorating fears for a return of inflation in major economies, dormant for the past decade. Rising U.S. bond yields and appetite for the dollar have carried the global Dollar Index to 92,183, the highest level in 14 weeks.
The U.S. Federal Reserve will meet to decide on monetary policy on March 17. The world's attention is on it signaling a possible intervention in the yield curve. But successive messages from Fed Chairman Jerome Powell and other committee members indicate that the bank will prefer to stand aside for now. It appears almost satisfied with yields aligning with higher inflation expectations, rather than moving to tackle rising prices.
Hence, there is strong external global pressure on emerging market currencies, which is not possible to counter merely by hiking interest rates. Most emerging currencies have been depreciating since the beginning of the year. Since the start of March, this depreciation has accelerated parallel to an intensification in sales of U.S. 10-year bonds.
The lira had stood out among peers in the first two months of the year, gaining the most among major emerging market currencies. But as the impact of external economic developments got stronger, the lira became the whipping boy again and depreciated the most.
While devaluation among emerging market currencies has become widespread, the lira has once again differentiated itself negatively, thanks to developments in domestic politics and foreign relations.
Outlining these Turkey-specific factors is important in grasping how the lira might recover some value.
Firstly, sentiment towards Turkey’s monetary policy is turning negative once more. Central Bank Governor Naci Ağbal, installed by President Recep Tayyip Erdoğan in early November, has done his best to deal with the wreckage left to him by the destructive era of former Treasury and Finance Minister Berat Albayrak, who resigned four months ago.
Ağbal’s hiking of the main policy rate to 17 percent from a previous 10.25 percent, after the lira hit a record low of 8.58 per dollar on Nov. 6, had worked wonders for the lira.
Foreign investors entered the domestic market from around 8.5 liras per dollar late last year and have made a decent chunk of money by taking on Turkish currency risk. Yet when the lira strengthened to around 6.9 per dollar last month, the rally lost momentum because local retail investors did not jump on the bandwagon by selling their dollar deposits. Room for short-term profit disappeared.
More importantly, since locals did not sell their extra foreign currency deposit buffers of some $40 billion to $50 billion and return to the lira, the central bank could not start planned foreign exchange purchases to bolster its depleted reserves of dollars and euros. The central bank’s forex reserves are now stuck at a negative $40 billion to $42 billion when taking account of liabilities.
Meanwhile, annual inflation has reached 15.6 percent. The appreciation of the lira has failed to spark a decline in core inflation measures. The increasing global price of oil and other commodities suggests that consumer price inflation will accelerate to between 18 percent and 19 percent by April. At the same time, public confidence in inflation data announced monthly by the Turkish Statistical Institute has deteriorated further, making it even less likely that locals will sell their foreign currency.
Confidence is a critical word here. The switch back to orthodoxy in Turkey’s monetary policy had only earned time for the government to correct its economic policy mistakes of last year, which included engineering a borrowing boom with low interest rates, and to introduce proper reform. Turkey's government, meaning President Erdoğan, could not use this moment well.
Erdoğan believed that the appreciation of the lira, a byproduct of high interest rates, was sustainable. This month, he also thought he could announce 'human rights reforms', the majority of which were already enshrined in Turkish law, to gain more credit with foreign investors, the European Union and the United States. He believed this even though he refused to comply with the judgments of the European Court of Human Rights. He has since given no sign that he will do so.
The president also thought he could use his public charisma, the promise of reform and an attempted reset in relations with Turkey’s neighbours to place a positive sheen over his mistaken purchase of S-400 air defence missiles from Russia. Through these steps, he thought he could convince U.S. President Joe Biden of the value of Turkey to the Western alliance just as he had persuaded his predecessor Donald Trump.
Now Turkey is faced with the prospect of more problems in its relations with the United States due to its growing intransigence on the Cyprus issue and an upcoming trial of the state-run Halkbank, which is accused of helping Iran evade U.S. sanctions. By May, it will become clear just how Turkey is stuck in a terrible predicament with regards to its ties with the world’s most powerful nation.
Erdoğan is also failing to grasp that the main problem for the Turkish economy is his government’s failure to move away from investing in a subsidised construction sector towards focusing on ways to increase output across the economy through transparent and effective economic reform. He is failing to initiate change because he is aware that the ruptures that were already emerging in the economic circles he had established around his governing Justice and Development Party (AKP), based on the use of state resources, would intensify.
The government’s aggressive growth ambitions, founded on the wrong model, keep creating economic problems, which become impossible to address. For quality economic growth, the authorities must sometimes endure economic contraction.
But the core of Turkey’s problems lies in the dynamics of the presidential system, which requires Erdoğan to gain more than 50 percent of the vote to preserve the extraordinary powers he narrowly acquired in a nationwide referendum in 2017.
According to Erdoğan, who is like a gambler, nationalism, runaway economic growth and the control of public discourse must all be accelerated. But this only serves to exacerbate his policy errors. Rather than unite Turkey, to stay at the top, Erdoğan is relying on creating deep splits below, in a destructive vicious circle.
The Turkish lira will not recover its previous value due to these deep rifts in society and the economy, which are nurtured under the presidential system. It is too late to pursue a policy of higher interest rates or so-called reforms in human rights or the economy to save the Turkish lira.
For the lira to recover, Turkey needs high-quality management. The way to achieve this is not through a new constitution, as Erdoğan is now proposing, that will reinforce the presidential system through the AKP’s partnership with the Nationalist Movement Party (MHP), one of the main architects of the catatonic situation.
The way to save the lira is to return to a pluralistic democracy. The initiative should be built on the common wisdom of both the AKP and opposition and by learning from the mistakes made during the previous parliamentary system and the great imbalances created by the presidential system.