Recep Tayyip Erdogan’s defence of recent interest rate cuts and declaration of an “economic war of independence” have sent the lira plunging and left analysts wondering how far Turkey’s president is willing to let the currency fall.
The foreign exchange component of central government debt hit 60 per cent of the total last month from 39 per cent in 2017.
Ankara appears to have a “tolerance for a weakening lira”, said Enver Erkan, an analyst at Terra Investment, adding that it was hard to predict how far policymakers would be willing to let it fall.
Analysts say dollar holdings could rise further, piling more pressure on the lira and creating a vicious cycle in which savers pull their cash, as was the case on a limited scale during the summer 2018 currency crisis.
But with the lira falling 15 per cent at one point on Tuesday, analysts warn the volatility could smother growth and that Erdogan’s approach could imperil the economy and fuel public discontent. Foreign currency deposits make up 55 per cent of the total — about $260bn — compared with 49 per cent in 2018.
High inflation risks fuelling currency weakness and stifling growth and could further undermine public support for Erdogan, whose two-decade rule was for years associated with rising prosperity.
“In recent years, Turkey has gone through multiple crises, and we’ve seen banks retain quite reasonable access,” said Huseyin Sevinc at Fitch, the rating agency.
Depleted net foreign exchange reserves weaken the central bank’s ability to defend the currency. According to Barclays, companies had deleveraged their external debt by $74bn, but some shifted to the public sector after the Treasury issued local debt denominated in foreign currency.
Erdogan, who has sacked three central bank governors since mid-2019, has insisted he will stay on the path of low-interest rates to stimulate growth and investment. More than 27 per cent yearly in the same month, food price inflation has hit low-income households especially hard.
Turkish bank customers can hold deposits in foreign currencies and the lira.
Annual inflation stood at almost 20 per cent in October, said the Turkish statistical institute. A consultancy, Jason Tuvey of Capital Economics, predicts inflation is “likely to rise to 25 to 30 per cent over the next month or two”. During previous bouts of lira weakness, Turkey eventually announced emergency rate rises that halted the slide in the lira and tamed runaway inflation. Turks have opted increasingly for dollars and euros in recent years as high inflation and low-interest rates have eroded returns on lira savings. While foreign financing has been resilient even in past episodes of currency stress, a sudden change in sentiment among foreign lenders could put the financial system under pressure. Forecasters, including the IMF, expect gross domestic product growth of 9 per cent this year — one of the fastest rates globally. “My concern is from this point on: would you want to keep your money in the Turkish banking sector?” said Phoenix Kalen, an emerging markets strategist at Société Générale.
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