lira as a reflection of all Turkey’s problems

(Repeat message from May 26, text unchanged)

LONDON/ANKARA, May 27 (Reuters) – The Turkish currency showed its growing dysfunction once again, falling to an all-time low of 20.05 lira to the dollar on Friday, two days before the decisive round of the presidential election. Meanwhile, investors are worried about what else might happen if Tayyip Erdogan stays in power for another term, possibly a decade. Erdonomics – the 69-year-old president’s unorthodox, growth-oriented economic policies – have collapsed the lira by 80% in five years, fueling inflation and undermining Turkish confidence in their currency.

Since the painful 2021 crisis, authorities have tightened their grip on currency markets to such an extent that some economists are already openly discussing whether the lira can be considered freely convertible at all.

Daily movements of the exchange rate became unnaturally small, but mostly always in one direction – down.

Tens of billions of dollars in foreign currency and gold reserves have been spent on this dance – and this is another manifestation of systematic micromanagement.

Exporting companies are now required to sell 40% of foreign exchange earnings to Turkey’s central bank, while the government continues to spend funds on the lira deposit support plan that helped calm unrest in 2021 and remains the main line of defence.

“The key is that the lira is artificially held in place,” says GAM’s Paul McNamara, calling some of Ankara’s measures de facto capital controls.

Over the past two months, customers have placed around $33 billion in lira-denominated asset-backed deposits, bringing the total to $121 billion, almost a quarter of all deposits in Turkey.

“It’s almost impossible to come out of it peacefully, calmly,” says McNamara.

Government sources who spoke to Reuters over the past few days indicate differences of opinion over what to do after the election: stick to the current economic strategy, which bets on low interest rates, or move to something more orthodox.

Currency controls have limited the lira’s daily decline by about 2% in the two weeks since the first round of the presidential election, but fears that Erdogan will not change course are very evident in other markets.

The cost of insolvency insurance for Turkey has increased by 40%. Benchmark international bonds fell 10-15% and a key currency volatility indicator, showing a year ahead and beyond, hit record highs.

Daron Acemoglu, a professor at the Massachusetts Institute of Technology, sees the mixing of different economic strategies and the melting of Turkey’s gold and currency reserves as the main problem: their gross value now stands at $105 billion, but excluding swaps and loans, reserves are negative by $115 billion.

“I am convinced that it cannot go on like this,” says Acemoglu. – Are lira bank accounts hedged against the dollar – is it a safe investment?

Potentially, these bank guarantees would be unsustainable for the government if a full-blown crisis broke out, points out the professor, who also sees the widespread double parallel exchange rate in Turkish bazaars reflecting dollar demand as a bad omen.

– We are going back to the 1990s – he laments, recalling the years when one of the worst economic crises in the country’s history was born, which resulted in the devaluation of the lira in 2001.

FINAL COUNTDOWN?

All attention is now focused on foreign exchange reserves and the lira has broken another historic barrier of 20 lira to the dollar.

According to Acemoglu, it is difficult to predict whether the situation will reach a tipping point – and if so, when. A strong tourist season should bolster foreign exchange reserves again in the short term, and recent injections into the treasury from the so-called friendly countries of the Persian Gulf and Russia also supported the Central Bank.

Before the election, JPMorgan predicted that the lira would weaken to 30 to the dollar if there was no clear return to traditional monetary policy.

Banking analysts now believe Erdogan will win on Sunday and deliver on campaign promises to boost household incomes and rebuild the country after February’s earthquake.

Some investors fear that if the market spirals again, the authorities may resort to draconian capital controls to cover the $230 billion external financing gap, or 25% of GDP, even though the government has repeatedly said that is not an option.

Authorities have already spent years squeezing international lira lending markets to the point where trading volumes in major centers such as London have fallen below $10 billion a day from an average of $56 billion in 2018, according to the Bank of England.

The growing inefficiency of the foreign exchange market has undermined the optimism that previously brought large amounts of foreign investment to Turkey.

“These were not cheap assets, they were considered jewels,” Acemoglu said.

What will happen if Erdogan wins? “I don’t see an easy way out,” says the economist.

(Mark Jones and Nevzat Devranoglu, translated by Anna Kozlova and Tomas Kanik)