Turkish Lira Crisis: Can the Currency Still be Considered a Free Float?

The unconventional policies advocated by the 69-year-old president with the aim of achieving growth have led to an 80 percent drop in the value of the lira over the past five years, perpetuating the problem of inflation and the collapse of Turks’ confidence in their currency.

Since the painful 2021 crisis, the authorities have played an increasingly practical role in foreign exchange markets, to the point that some economists are now openly debating whether the lira can still be considered to have floated freely.

The daily movements of the lira have become abnormally small and are mostly heading in one direction, which is to decline.

Exporting firms are now required to sell 40 percent of their foreign exchange earnings to the central bank, while the bank deposit protection scheme, which helped stem the turmoil of 2021, remains a crucial, if potentially costly, wall of defense.

“The main thing is to artificially maintain (the value of) the lira,” said Paul McNamara, director of emerging market debt at GAM Asset Management.

Depositors have put about $33 billion into bank accounts protected under the scheme in the past two months, bringing the total to $121 billion, nearly a quarter of all Turkish deposits.

“Fundamentally, it’s impossible to find an easy, good solution to all of this,” McNamara said.

credibility

Sources familiar with the government who spoke to Reuters in recent days said that a dispute is currently raging over sticking to the current economic strategy that prioritizes low interest rates or shifting to more traditional policies after the elections.

Close management of the lira limited its decline to just over 2% since the first round of presidential elections two weeks ago, but other major markets indicated strong fears that Erdogan would not change course.

The cost of insuring Turkey’s debt against default rose 40 percent, international bonds fell between 10 percent and 15 percent, and key measures of volatility in the foreign exchange market over the next one year or more hit record highs.

Daron Acemoglu of the Massachusetts Institute of Technology says the problem is the policy mix and dwindling foreign exchange and gold reserves.

Acemoglu added, “I am convinced that what we have now cannot continue.”

“Dollar-protected lira accounts, are they credible?” he asked, pointing to their potential cost to the government in the event of a full-blown crisis and the fact that parallel exchange rates are now widely offered in Turkish markets due to the demand for dollars.

“We are going back to the 1990s,” he added, referring to a period that preceded one of Turkey’s most severe crises, which culminated in a sharp currency depreciation in 2001.

Has the final countdown begun?

Attention is now turned to foreign exchange reserves and the lira, as it exceeded the 20 level against the dollar, which is the latest major stop in its long downward journey.

Acemoglu said it was difficult to predict whether or when a crisis would occur. The strong tourist season is expected to boost reserves again in the short term, and state coffers have recently received inflows from “friendly” Gulf countries and Russia as well.

In the run-up to the elections, analysts at JP Morgan expected the lira to drop to 30 against the dollar without a clear shift towards traditional policies.

These analysts now assume that Erdogan is assured of victory on Sunday and will fulfill his campaign promises to increase income and rebuild the country after the February earthquake.

Some investors worry that if the market picks up again, the authorities could resort to more stringent capital controls, something the government has repeatedly said it is not considering as it seeks to close the $230 billion external financing gap, or 25 percent of the country’s gross domestic product.

The government has relied for years on international lira lending markets to such an extent that Bank of England data shows trading in major centers such as London has shrunk to less than $10 billion a day on average from $56 billion in 2018.

The growing imbalance in the currency market has eroded the optimism that previously brought many foreign investments to Turkey.

On the peak of the boom in mergers and acquisitions in the banking sector, Asim Oglu said, “These assets were not seen as cheap assets, but were seen as jewels.” In response to a question about the situation Erdogan faces now, assuming he wins, he said, “I don’t necessarily see an easy way out.”