Turkish lira weakens as economists warn of economic challenge

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The Turkish lira weakened in the aftermath of Recep Tayyip Erdoğan’s re-election as analysts warned the next big test for the victorious president would be dealing with the country’s wobbly $900 billion economy.

Many economists argue this Erdoğanlow interest rate policies and emergency measures to prop up the currency cannot continue. The lira hovered around record lows on Monday after breaching TL20 against the US dollar late last week.

“The current policy stance has become untenable,” said Liam Peach of Capital Economics in London. “Turkey cannot continue with very low interest rates, very loose fiscal policy and burn all sorts of foreign exchange reserves much longer.”

TurkeyReserves have fallen by about $27 billion this year as the country has attempted to shore up the lira and finance a near-record high current account deficit.

Official data put reserves, including foreign exchange and gold, just above $101 billion.

However, according to JPMorgan, net reserves, a figure that excludes liabilities, are effectively zero and profoundly negative if you exclude tens of billions of dollars in money borrowed from the local banking system.

Clemens Grafe, an economist at Goldman Sachs in London, said reserves were now “close to levels where previously the lira’s volatility had risen markedly.”

But immediately after insuring her victory in Sunday’s runoff with 52% of the vote, Erdoğan insisted he would maintain his low interest rate policy, even though inflation is currently over 40%.

“If anyone can do it, I can do it,” he said. “[The central bank’s main interest rate] it has now been reduced to 8.5 per cent and you will see that inflation will also come down.’

He added that “eliminating the problems of rising prices caused by inflation and the loss of welfare are the most pressing issues of the coming days” – but did not provide details.

Investors are also worried about the equivalent of $121 billion the Turks have put into special savings accounts to pay off at government expense if the lira depreciates.

The measure has slowed the rate at which Turks have bought foreign currencies, but Nureddin Nebati, finance minister, said the bills had cost the country an estimated 95.3 billion Turkish lira ($4.7 billion) since they were introduced in 2021.

The blow to public finances could mount rapidly if the lira falls faster in the coming weeks.

However, Erdoğan may be able to tap into fresh funding from allies in the Middle East and Russia, analysts argue.

The president said last week that unnamed Gulf states had contributed funds to help stabilize Turkey’s markets, but he didn’t elaborate.

Erdoğan would likely get a short-term boost from cash receipts from summer tourists that tend to ease strains on the country’s finances, said Wolf Piccoli of consultancy firm Teneo.

Turkey’s Bist 100 stock index, which was boosted by locals seeking refuge from high inflation, also jumped more than 4% on Monday.

Some economists say Erdoğan could appoint a new economic team, bringing back names well known to foreign investors.

“With the election behind us, all eyes will be on the composition of the economic team and the credibility of the initial policy response,” said Ilker Domac of Citigroup.

But Domac also warned that it would be “increasingly difficult” for the Turkish central bank to keep interest rates far below inflation, “particularly during the last quarter of the year and beyond.”

Other economists have signaled a greater degree of alarm.

“Prepare for the worst, which could involve formal capital controls or major flight of deposits from the banking system,” wrote Atilla Yesilada of consultancy GlobalSource Partners in Istanbul.