Turkey’s Self-inflicted Crisis of Confidence
Turkey appears closer to a fullblown currency crisis today than at any point since the ruling AK party took power in 2002. In the past three months, the lira has lost almost a fifth of its value against the dollar, as both global and domestic investors lose confidence in their country’s economic prospects. Previous episodes of lira weakness, in 2011 and 2014, were driven by external events - the eurozone debt crisis and the “taper tantrum” that hit many emerging markets. This time, the main worries are Turkey’s worsening security problems and its turbulent politics.
Some of the damage is due to circumstances beyond the government’s control, but much of it is self-inflicted. The lethal spill-over from the Syrian conflict has been worsened by Turkey’s initial tolerance of jihadi networks and President Recep Tayyip Erdogan’s decision to sacrifice a chance of peace in the Kurdish south east for electoral gain.
A purge of suspected Gulenists following July’s attempted military coup has become indiscriminate. Its effects on business are wide-ranging. Arrests of executives and asset seizures disrupt supply chains; officials hesitate to sign routine documents in case they are later deemed complicit with a Gulenist company; and foreign investors fear their partners may be implicated.
All this is already having a sapping effect on the economy, which suffered a sharp contraction in the third quarter. The lira’s weakness is bound to exacerbate this. Turkish companies have historically been adept at managing large foreign currency debts, but even if they avoid default, many of them will now come under strain. Cash that could have been used for investment will have to go towards debt service; and lay-offs may become necessary, at a time when the slump in tourism is already adding to unemployment.
Add to this a rising oil price that will widen Turkey’s notoriously large current account deficit, and expectations of rising US interest rates that will present a challenge for many emerging markets. It would not take much to make foreign lenders reconsider their huge exposure to Turkey’s banks.
The government is using some of the levers at its disposal to prop up consumer demand and to mitigate the effects of the lira’s fall. But it remains unwilling to confront the reality that the central bank does not have the reserves needed to fight off a sustained run on the lira, and a swift and sizeable increase in interest rates is necessary to stabilise the currency.
In 2011 and 2014, the central bank did indeed deliver emergency rate rises to stem depreciation. Now, its independence eroded by years of threats and hectoring from Erdogan, its ability to act is in doubt. The president, having dispensed with most of his more orthodox economic advisers, believes high interest rates cause rather than quell inflation. He prefers to blame economic problems on a nefarious conspiracy of international financiers.
In this context, the suggestion that investors will regain confidence if Erdogan can only secure the executive powers needed to complete his grip on power is absurd. He threatens the basic functioning of Turkey’s institutions.
True, there might be a temporary respite from electioneering - and markets often prefer predictable autocracy to ineffectual democratic governments. Voters too will sometimes accept economic hardship if it can be blamed on outsiders - witness Vladimir Putin’s popularity since the sanctions deployed against Russia. But it is unlikely that Turkish voters - who first backed Erdogan because he promised and delivered unprecedented prosperity - will feel the same way.