Turkey Chaos Exceeds Historical Recipe

Today’s TRY/CBRT/diplomatic chaos has opened a new chapter in long accustomed high inflation- sinking lira episodes as economic and financial sector crises repeat on a regular basis.  Four decades ago was the run-up to the military coup when inflation had hit triple digits, the old TL was worthless, and lack of reserves and a 5% current account gap resulted in severe shortages. Daily ekmek (bread) purchases were made first thing in the morning before the currency fell and prices hiked, and traditional Turkish coffee was not available as it was all exported to try to boost reserves.  The domestic political situation was dire with the right-left violence throughout the country amid an ever-changing parade of prime ministers, while geopolitically the country’s 1974 invasion of Cyprus was condemned.

Fast-forward past the crises of 1994, 2000/2001, and 2018 to today. The long-time NATO member has antagonized counterparts for several years. Purchases of Russian weaponry and pledges of further deals with the Kremlin on military and energy issues, maritime disputes in the Mediterranean, and the targeting of Kurds in Syria have dented, if not broken, traditional diplomatic ties. The latest threat to oust ten Western ambassadors to Turkey after they demanded release of a high-profile philanthropist accused of participating in the failed 2016 coup attempt just days before the G-20 summit further escalated tensions. While President Erdogan backed down, the country’s largest trade partners will not soon forget the incident.

His “diplomatic” policies have compounded the more “traditional” economic/currency crisis. While some argue that the TRY’s fall in recent months has boosted the current account as exports experience a late-pandemic rebound, spiking energy, food, and commodity prices are the flip side.  The country’s energy import bill was up over 100% year/year in August and accounted for nearly 20% of the total.  At the same time, input costs needed for exports rose on global supply chain disruptions.

Portfolio investors largely gave up after central bank head Naci Agbal was ousted for hiking rates in March.  Foreign holdings of local government bonds slumped to less than 5% of the total outstanding from a high of 30% in 2013. Despite regular bouts of volatility, Turkey had long been a popular “carry-trade” for fixed income investors.  Last week’s 200 basis points cut in the key policy rate surprised in size. While one was foreshadowed after three members of the CBRT’s monetary policy committee members were fired – which sent the TRY spiraling downward – the steep move shocked investors.  In the past four weeks more than USD 800 million of foreign investment has exited the Istanbul Stock Exchange down 25% in USD terms on the MSCI Index so far this year, almost the same amount the TRY has lost against the greenback. Informal bets are now on when the TRY crosses the 10/$ mark with inflation near 20%.

While President Erdogan continues to return to his illogical, long-held argument that high interest rates result in high inflation, Turks at home are increasingly giving up on the TRY for hard currency.  The Treasury and Finance Ministry are clearly concerned. They recently mandated FX bureaus to record identity cards of every citizen that exchanges TRY for USD. Already more than 50% of domestic bank deposits are in foreign currencies, and the government may be out of tricks as in 2018 when it raised taxes on FX and slashed them on TRY deposits to slow depreciation.  

With no end in sight to “unconventional” monetary policy driven by a head of state rather than an independent central bank, with a layer of diplomatic and military misadventure to boot, investors can only wait for sweeping regime change. Elections must be called by June 2023, the year Turkey marks its centenary. Opposition parties banding together may hold the best chance for a reversal of the state’s decline in investor portfolios and Western allies’ trust, but their economic platform has yet to be fully shaped and has scared the business and banking communities in the past. The 40 year bumpy ride in Turkish assets is far from over, but the pre-ordained self-inflicted crashes may not be as uniform so as to constitute a perverse rally.