Turkish President Recep Tayyip Erdogan’s defense of recent interest rate cuts and the declaration of the “War of Economic Independence” plunged the lira, leaving analysts wondering how far he is willing to devalue the currency.
Erdogan has fired three central bankers since mid-2019 and is a lifelong opponent of high interest rates. He insists that he will continue to follow the path of lower interest rates to stimulate growth and investment. Forecasting agencies including the International Monetary Fund predict that this year’s GDP growth rate will be 9%, one of the fastest growth rates in the world.
But as the lira fell 15% on Tuesday, analysts warned that currency fluctuations could severely inhibit future growth. They say that Erdogan’s approach poses serious risks to the health of the country’s financial system and wider economy—and the prospect of public dissatisfaction. They see four main pressure points.
Will more Turkish depositors switch to the U.S. dollar?
Turkish banks allow customers to hold deposits in foreign currencies and lira. In recent years, as high inflation and low interest rates have eroded the return on lira savings, Turks have increasingly chosen to keep their funds in U.S. dollars and euros. Foreign currency deposits accounted for 55% of all deposits in the country’s banking industry, or about $260 billion, compared to 49% in 2018.
Analysts worry that dollar holdings may increase further, putting more pressure on the lira and creating a vicious circle.
What they ultimately worry about is that people will lose trust and seek to withdraw cash, which happened on a small scale during the last currency crisis in the summer of 2018. banking? Said Phoenix Kalen, emerging market strategist at Société Générale.
Bank runs were run. When customers lost confidence and rushed to withdraw their deposits, the last time it appeared in Turkey was in 2001. In this case, the government can choose to implement capital controls, such as taking measures to make it more difficult to withdraw hard currency, although it has previously insisted that it will not do so.
How far will house prices rise?
Soaring prices have become the top priority of Turkey’s political agenda. According to data from the Turkish Statistics Agency, the annual inflation rate in October was close to 20%. In the same month, food prices rose by more than 27% year-on-year, which hit low-income families particularly hard.
Turkey’s dependence on imported goods, especially energy and raw materials, means that currency depreciation will quickly translate into higher prices. Jason Tuvey of Capital Economics, a consulting firm, predicts that inflation “may now rise to 25% to 30% in the next one or two months.”
As consumer confidence takes a hit, high inflation may exacerbate currency weakness and curb growth. It may also further weaken public support for Erdogan, whose two-year rule has been closely related to growing prosperity for many years. The opposition won control of the country’s two largest cities in municipal elections after the 2018 crisis, and they hope to hold elections early in order to take advantage of growing unease about the economy.
The depletion of the central bank’s net foreign exchange reserves means that its ability to intervene to defend the currency is limited. During the first few periods of lira weakness, including 2018, Turkey finally announced an emergency interest rate hike to prevent the lira from falling and curb uncontrolled inflation. However, given Erdogan’s tight control of the central bank and his hints for more interest rate cuts, some analysts asked if this time was different.
Enver Erkan, an analyst at Terra Investment based in Istanbul, said the government seems to “tolerate the devaluation of the lira,” adding that it is difficult to predict how far policymakers are willing to devalue the lira.
Will the bank retain access to foreign funds?
Turkish banks rely heavily on borrowing from abroad to finance domestic loans.
Although foreign financing remained resilient even in past periods of extreme currency stress (such as 2018), sudden changes in foreign lenders’ sentiment may put pressure on the financial system.
“In recent years, Turkey has experienced multiple crises and we have seen banks retain fairly reasonable access,” said Huseyin Sevinc, who is in charge of Turkish banking at the rating agency Fitch. He added that the lender has successfully extended its syndicated loan from abroad this year.
He said that banks “have a large amount of foreign exchange liquidity buffers to cope with short-term market closures of about a year,” but warned that “prolonged market closures may pose significant risks.”
Is Ankara able to repay its debts?
During the currency crisis in 2018, the lira fell by 18.5% in the U.S. for one consecutive day, sparking broader concerns among investors about the economy. One of the biggest concerns was whether the country’s heavily indebted corporate sector could repay loans denominated in dollars and euros.
According to Barclays Bank, three years later, the company is in better condition, with its external debt deleveraging US$74 billion. Conversely, under the supervision of the former Finance Minister Berat Albayrak, after the Ministry of Finance began issuing local debt denominated in foreign currency, some of the foreign debt has been transferred to the public sector.
The foreign exchange component of central government debt reached 60% of the total last month-up from 39% in 2017. This means that as the currency depreciates, the cost of the Ministry of Finance to repay the debt burden becomes higher.
Compared with emerging market countries, Turkey’s overall debt-to-GDP ratio is still low, about 40% of GDP. But analysts said that when the government plans to increase gifts as the election approaches, rising debt servicing costs may limit the government’s fiscal space.