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What the collapse of the lira means for the Turkish economy

Turkish President Recep Tayyip Erdogan’s defense of recent rate cuts and declarations of an “economic war of independence” sent the lira plunging and left analysts wondering whether Are you willing to let this currency depreciate again?

Erdogan, who has sacked three central bank governors since mid-2019 and is a longtime opponent of high interest rates, has insisted that he will continue down the path of low interest rates in an effort to stimulate growth. and investment. Forecasters including the IMF expect gross domestic product growth of 9% this year – one of the fastest in the world.

Column chart of % year-to-year change against the US dollar shows the Turkish lira's historical decline

But with the lira falling 15% on Tuesday, analysts warn that currency volatility could dampen future growth. According to them, Erdogan’s approach carries serious risks to the health of the country’s financial system and the broader economy – as well as the prospect of growing public discontent. They see four key pressure points.

Will more Turkish savers turn to dollars?

Turkish banks allow customers to hold deposits in foreign currencies as well as in lira. In recent years, Turks have increasingly chosen to keep their money in dollars and euros as high inflation and low interest rates have eroded the return on savings in lira. Foreign currency deposits make up 55% of all deposits in the country’s banking sector – about $260 billion – compared with 49% in 2018.

Analysts fear that dollar holdings could climb even higher, putting more pressure on the lira and creating a vicious cycle.

Their ultimate fear is that people will lose confidence and find ways to withdraw their cash, which happened on a small scale during the last currency crisis in summer 2018. “Concerns Mine is from this point: would you rather keep your money in the Turkish banking sector?” said Phoenix Kalen, an emerging markets strategist at Société Générale.

The last time banks lost confidence and rushed to withdraw deposits, the last time it was terrible for banks was 2001. In such a scenario, the government could choose to impose measures. capital controls, such as measures to make hard withdrawals more difficult, although it previously said it would not do so.

How high will the price go?

Soaring prices have become at the top of Turkey’s political agenda. According to the Turkish Statistical Institute, annual inflation was near 20 percent in October. Food price inflation, more than 27 percent year-on-year, has hit low-income households heavily. short.

Column chart Annual change in consumer prices (%) shows Inflation in Turkey near 20%

Turkey’s reliance on imported goods, especially energy and raw materials, means a currency decline that quickly translates into higher prices. Jason Tuvey, of consulting firm Capital Economics, predicts inflation “is now likely to rise to 25 to 30 percent in the next month or two.”

High inflation risks fueling more currency weakness and stunting growth as consumer confidence suffers. It could also further weaken public support for Erdogan, whose two decades in power have been associated with growing prosperity. The opposition, which gained control of the country’s two largest cities in municipal elections in the wake of the 2018 crisis, wants early elections so they can take advantage of growing uncertainty over with the economy.

The depletion of the central bank’s net foreign exchange reserves means that the central bank’s ability to intervene to protect the currency is limited. During previous lira weakness, including 2018, Turkey finally announced an emergency rate hike to stem the lira’s slide and curb runaway inflation. However, given Erdogan’s tightening grip on the central bank and his hints of more rate cuts, some analysts question whether this time around is different.

Enver Erkan, an analyst with Istanbul-based Terra Investment, said the government appeared to have “tolerance for a weakened lira”, adding that it was difficult to predict how policymakers would react. willing to let the lira depreciate how much.

Will banks have access to foreign capital?

Banks in Turkey rely heavily on borrowing from abroad to finance domestic lending.

While foreign financing remains resilient even during periods of extreme currency stress in the past, such as 2018, the abrupt shift in sentiment among foreign lenders could put the financial system under pressure.

Huseyin Sevinc, head of Turkish banks at rating agency Fitch, said: “In recent years, Turkey has gone through many crises and we see banks retain access to quite reasonable. Lenders this year have been successful in relocating their syndicated loans from abroad, he added.

“Banks have significant foreign currency liquidity buffers to warrant a short-term market close in about a year,” he said, but warned: “A prolonged market closure could carry significant risks. . ”

Will Ankara be able to pay its debts?

During the 2018 currency crisis, when the lira fell as much as 18.5% in just one day after a row with the United States raised concerns among many investors about the economy, one of The biggest is the ability of the country’s heavily indebted corporate sector to repay its loans in dollars and euros.

Three years on, companies are doing better, having written off $74 billion in foreign debt, according to Barclays. Instead, some of that external debt has gone to the public sector after the Finance Ministry began issuing domestic debt in foreign currencies in the view of former Finance Minister Berat Albayrak.

The foreign exchange component of central government debt hit 60% of the total last month – up from 39% in 2017. That means that as currencies slide, Treasuries become more expensive to shoulder the burden. its debt.

Turkey’s overall debt-to-GDP ratio remains low compared to its peers in emerging markets, at around 40% of GDP. But analysts say rising debt repayment costs could limit the government’s fiscal space at a time when it is planning to increase gifts once elections are over.

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