President Recep Tayyip Erdogan has hailed the recent period of calm in the Turkish lira as a sign that the economy is about to enter the “strongest period in the history of Turkey”.
That bold declaration comes after Erdogan, a staunch opponent of high interest rates, triggered a collapse in the currency at the end of last year when he ordered the central bank to aggressively cut borrowing costs despite soaring inflation.
Emergency measures — including a multibillion-dollar backdoor intervention by the central bank — have helped to restore calm in the currency markets. But inflation continues to climb, reaching almost 50 per cent in January, and it is unclear if the lira stability can last.
Some political analysts believe the Turkish president is simply trying to muddle through until he can call an early election — bringing forward parliamentary and presidential votes scheduled for June 2023 — in the hope of securing another five years in office.
“Holding things steady for a campaign period might be all he needs to win,” said Alp Coker, head of the Turkey desk at the London-based consultancy GPW. “Short-term solutions can work politically. It doesn’t need to work for a long time for it to translate into political success.”
Here are five key things that must go Erdogan’s way if he is to keep the lira steady in the coming months.
Can Turkey run a current account surplus?
Turkish authorities are gambling on turning the country’s chronic imbalance between exports and imports, which sucks foreign currency out of the country and puts pressure on the lira, into a surplus.
That requires limited consumer demand at home — something Erdogan may be unwilling to tolerate if he wants to pump up the economy ahead of elections. It also needs strong tourism revenues this summer and the avoidance of further escalation in tensions between Ukraine and Russia.
A conflict could cause a sharp rise in the price of energy, a key component of Turkey’s import bill.
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Some analysts are sceptical, but Ugras Ulku, of the Washington-based Institute of International Finance, predicts that Turkey will run a $4bn surplus this year — compared with deficits of $15bn in 2021 and $36bn in 2020 — thanks to limited imports and booming exports and tourism. “We project that tourism revenues will recover fully to 2019 levels,” he said.
Will Turks stop putting their money in dollars?
At times of turmoil, Turks often prefer to keep their savings in accounts denominated in dollars, euros and precious metals — a phenomenon known as dollarisation that has been a source of pressure on the lira. At the end of last year, 64 per cent of all deposits in the banking system were in foreign currency or precious metals, according to central bank data.
That figure has fallen to 60 per cent after the launch of a savings scheme, unveiled in December, that promises to protect savers against exchange rate losses if they convert their dollar and euro holdings into lira. About $13.7bn out of foreign currency savings had been switched by February 14, according to data from the country’s banking regulator. That has helped to bolster the national currency and bring down total foreign currency deposits from about $264bn at the end of last year to about $251bn.
Will that trend continue if, as analysts expect, inflation tops 50 per cent in the months ahead and stays at that level for much of the year? “I’m expecting the volumes to grow, but for them to taper off over the coming months as inflation continues to be very high,” said Phoenix Kalen, global head of emerging markets research at the French bank Société Générale.
With average deposit rates standing at 17 per cent in mid-February, the value of savers’ money still faces severe erosion once inflation is taken into account. While the government predicts that inflation will fall to single digits next year, Kalen warns that there is a strong risk that the government will “grossly exceed its inflation forecast”.
Will foreign investors come back to Turkey?
Erdogan argues that his “new economic model” will attract foreign direct investment that will bring hard currency into the country. Even with rock bottom valuations, western investors who have traditionally been the strongest source of FDI into Turkey remain hesitant due to concerns about the country’s economic management and the rule of law.
However, a recent diplomatic thaw with the United Arab Emirates came with a promise of a $10bn investment from the Gulf nation. Last month, the UAE struck a $5bn swap agreement with Turkey that bolstered the headline reserves of the country’s central bank.
Ankara hopes that a drive for détentes with other regional nations, including Saudi Arabia, Israel and Armenia, will provide a further boost to trade and investment. But GPW’s Coker warned that there had not been any sign of “frenzied dealmaking to buy up Turkish assets” as yet.
Will Turkish companies be able to roll over their debt?
Turkey is, to some extent, sheltered from volatility in global equity and bond markets because flighty portfolio money, which can be pulled out at a moment’s notice, has largely already left. But the country is still reliant on foreign finance for its banks and corporate sector. It has close to $170bn in external debt coming due in the next 12 months.
If the US Federal Reserve starts raising interest rates next month and ending its programme of asset purchases as some analysts predict, this would “increase the challenges” of rolling over that borrowing, said Selva Demiralp, professor of economics at Istanbul’s Koc University.
If companies and banks have to repay foreign debt, rather than having it extended, that would create demand for foreign currency and put renewed pressure on the lira. Demiralp believes, however, that the Fed may end up being less hawkish than markets fear. “Three [interest rate] hikes in 2022, as opposed to six to seven hikes, would clearly be good news for Turkey, which is already sitting on a fragile equilibrium,” she said.
Can the central bank keep intervening?
At least some of the recent stability in the lira is thanks to intervention by the central bank, which sells dollars and buys lira at times of turmoil in a bid to bolster the local currency.
While Turkey’s headline gross reserves have shown a marked improvement in recent weeks, net reserves are still deeply negative once money borrowed through swap agreements with domestic lenders and international central banks is stripped out — standing at about minus $50bn on February 16, according to Goldman Sachs. That means limited firepower for further interventions. A current account surplus and continued de-dollarisation would help the bank build up its war chest.
But if those things fail to materialise, the central bank could struggle. “How far can they keep going with negative net reserves? Of course, it depends on the flows in the markets,” said Ugur Gurses, an economics commentator and former central bank official. “But it’s a kind of a gamble . . . If you deduct swaps and gold, they’ve got a very small amount of reserves left in their pockets.”
