It has long been my contention that the biggest chink in Turkey’s economic armor is the country’s chronic current-account balance-of-payments deficit, which is being covered with inflows of (mostly) short-term money from abroad. This makes it essential for Ankara to retain the confidence of foreign investors, but the regime of President Recep Tayyip Erdogan has been doing a lousy job of this and now the Turkish economy as well as the lira are suffering from the repercussions. Indications are that Mr. Erdogan and his ruling Islamist Justice and Development (AK) Party are not about to change their policy direction, so that economic conditions are apt to get worse before an improvement can realistically be hoped for.
Mr. Erdogan and his supporters seem determined to turn back the clock on the reforms of Mustafa Kemal Ataturk, which back in 1923 transformed the Ottoman Sultanate into a secular republic. They have been pushing what is best described as “creeping Islamization” (not very well received in urban centers such as Istanbul and Izmir, but finding at strong echo in the Anatolian hinterland) and are seeking to concentrate all the levers of government power in the office of the President. The latter has become increasingly dictatorial and intolerant of dissent, making it clear that he meant it when he compared democracy to a street car useful for taking you to your destination (meaning power), “at which point you get off.”
At this time, Turkey is still under the state of emergency that Mr. Erdogan imposed after he survived a coup attempt last July. Part of the problem is that the country has just gone through its bloodiest period in history, having suffered 269 separate terrorist incidents and seen 685 people killed and over 2,000 wounded in the past 12 months. The AKP-dominated parliament has given preliminary approval to a new constitution that will grant Mr. Erdogan the executive presidency he covets. But he is not yet, apparently, finished with the purge that has been his response to the putsch attempt. Rather than trying to heal his divided country, Erdogan has cracked down hard on all his opponents, from Kurdish activists to leftists and secularists. Since the coup, more than a hundred journalists have been locked up. Almost 14,000 policemen and soldiers have been jailed, including nearly one of every two military generals.
The purge, a targeted strike against people linked to Fethullah Gulen, an exiled cleric whom Erdogan blames for the failed coup, has reached into nearly every sector of Turkish society. In all, more than 100,000 civil servants have been fired from their jobs and at least 30,000 people have been arrested, including not only army officers and journalists but also teachers, security personnel and opposition politicians. Hundreds of businessmen have been rounded up and an estimated USD 10 billion in assets from more than 600 companies have been confiscated. At this stage, all business owners have to worry that their partners could be jailed tomorrow, that their supply lines could be shut down, or that their bankers are targeted by the regime and their executives may be thrown behind bars.
No wonder the mood in the business community is one of anxiety and fear. Transactions are being hampered, investors are being scared off, and normally risk-taking entrepreneurs are withdrawing into the safety of defensive positions. No wonder gross domestic product contracted already in last year’s third quarter, by 1.8% year-on-year, with worse numbers to come. No wonder the lira has been in a steep nosedive in the foreign exchange markets. The unit has tumbled by as much as 12% against the US dollar since the start of this year, after losing one-fifth of its value in 2016, and there is every reason for believing that it will stay vulnerable on the downside. The problem of Turkey’s current-account BoP deficits and reliance on inflows of “hot money” is exacerbated by the fact that the mismatch between the foreign-currency-denominated loans on the books of Turkish corporates and their assets has widened to USD 231 billion.
Standard & Poor’s and Moody’s both downgraded Turkey’s credit rating last year and both now have it at the junk level. The country’s remaining investment-grade rating, from Fitch, may be junked when the company issues a review on January 27. Already last October, Turkey’s short-term external debt amounted to 74% of total reserves. About half of it is denominated in dollars at a time of rising US interest rates. And as the arrests of alleged coup plotters reach ever deeper into the business community, capital flight is virtually certain to get worse, helped along by the erosion of judicial independence and by attempts on the part of the ruling AKP to reward loyal supporters with confiscated assets. To date, foreign banks have been largely prepared to roll over their huge syndicated loan exposure to Turkey, but as the economy keeps slowing and the lira continues to drop this backstop may start to erode.
The orthodox response to such a situation would be a drastic interest rate hike by the Central Bank. Turkiye Cumhuriyet Merkez Bankasi raised rates moderately last November for the first time in nearly three years, and it next meets to decide policy on January 24. But no really aggressive moves are to be expected, since Mr. Erdogan, eager to support economic growth, has convinced himself that high interest rates are the cause, not the nemesis, of inflation and currency weakness. He prefers to compare those selling the lira and buying hard currency to terrorists. Their aim, according to him, “is to bring Turkey to its knees, to take over Turkey, and to distance Turkey from its goals.” Erdogan opines that “they are using the foreign exchange rate as a weapon.”
The CB has initiated a number of half-measures that are highly unlikely to provide solid and lasting support for the lira. Inter alia, it has loosened foreign-currency reserve requirements by half a percentage point. It has also halved commercial banks’ borrowing limits in the interbank money market. This leaves the question wide open whether it has any freedom to act against the wishes of the President and it leaves investors and creditors wondering whether the worst for the currency and the economy is yet to come. Given geopolitical upheavals in the region, the upcoming plebiscite on granting the President wide-ranging powers, investor nervousness and the impact of the recurring terrorist attacks on tourism, I believe it is.