In the face of spiralling inflation and a host of other concerns, both in its domestic economy and the global geopolitical stage, Turkey has remained on its path to “permanent liraisation,” a three-pronged effort to stabilise the value of its currency while at the same time “de-dollarising” its economy.
As inflation exerts pressure on the world economy, a tumult in Eastern Europe disrupts various facets of the trade, and much of the world has grown more hawkish economically, Turkey’s resolve could either produce the stability it has sought or lead to macroeconomic calamity.
Turkish policy
ING’s chief Turkish economist Muhammet Mercan and colleague Chris Turner outlined the policy, its aims and the risks that threaten its success in a note published Tuesday.
“This (strategy) is built on three pillars: new financial products, collateral diversification, and liquidity measures,” Mercan wrote.
These policy measures discourage foreign currency savings and conversions, and incentivise savings, bonds and conversions from foreign currencies, for both Turkish residents and Turkish nationals living abroad within the EU and beyond.
The notion of repatriating savings to Turkish banks and in Lira was not novel, as Mercan noted. Turkey had success with a similar program throughout the ’80s, ’90s and early 2000s that amassed some $19bn (£14.32bn) in 2004. Those reserves were all but depleted, and the new program aimed to restore their prior levels. The intervention also included interest- and dividend-related incentives.
Lowering interest rates
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While much of the world has begun implementing interest rate hikes and counter-inflationary policies, the Turks lowered rates four times for a total of 500 basis points to 14%, and have steadfastly resisted pressure for subsequent bumps even as the lira (TRY) lost half its value.
Thus far, the CBT’s positions have improved as a result of the policies, which, in the near term, have proven efficacious, albeit with the caveat that medium-sight and long-haul prospects are weighed down by risks.
Quelling the desire for dollars and gold, which Turkey accomplished initially, may be particularly challenging at a moment when both appeal to hedge-heavy and risk-averse investors. Thus far, results in Turkey have been positive to some degree, including growth on a national level and rising export levels.
“The improvement since the beginning of this year reflects not only the increase in its FX purchases related to conversions to the FX-protected scheme (more than $20bn) but also FX purchases related to exporters’ FX sale requirements (there’s no official data for the time being),” Mercan wrote. “On the flip side, selling FX to SEEs that reached an all-time high in February and the decline in banks’ swap stock with the CBT are the other factors that impacted reserve developments.”
Risk factors
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Mercan and Turner identified soaring inflation in Turkey against a backdrop of intense inflationary pressures elsewhere. Turkish trade, as well as tourism dependence on Russia, the broadening of current account deficits and a national policy that seems irreconcilable with global circumstances, are emergent obstacles.
Even prior to the Russia-Ukraine conflict and some of the alarming inflation figures coming from global powers, Turkey had hit a two-decade high with CPI inflation topping 54%. Import prices, food prices, energy prices and more – practically every known inflationary indicator – all demonstrate upward momentum.
“It is not only rising inflation expectations and the FX pass-through but also other demand-pull and cost-push factors – including rapid uptrend in global commodity prices – which have increased inflation significantly,” Mercan wrote. “Given the broad-based deterioration in price dynamics, risks continue to lie significantly on the upside… higher inflation, leading to even deeper negative real rates, should cloud the currency outlook and raise significant challenges to the current policy framework.”
Mercan also remarked that external financing could become more challenging for Turkey as interest rates rise elsewhere and that its current account deficit could also become a significant concern.
“Given that negative real rates reduce the incentive to save, and oil prices are on the rise, the external balance will remain under pressure in the near term. The outlook for the whole year will be determined by tourism revenues and oil,” Mercan wrote. “The risk of oil prices remaining higher for longer given the ongoing conflict between Russia and Ukraine will be a negative, while the slowdown in economic activity and weaker core imports can be a limiting factor.”
Darkening such projections are Turkey’s relationships with Russia and Ukraine. The two nations represent more than 28% of tourism to Turkey annually; Russia supplies oil (17.3% of imports) and natural gas (44.9%), and Turkey also has links to both nations in terms of wheat trading and construction projects.
Short-term thinking
Perhaps the chief critique of the liraisation policy has been that it is an elaborate stopgap with only short-term remedies to offer, meaning inflation could continue to accelerate and soon be accompanied by shrinking GDP.
“High inflation ultimately stalls real GDP growth over the long term. This is not good for Turkey, long-term,” BlueBay Asset Management Strategist Timothy Ash told CNBC in an interview. “(Erdogan) is running the economy extremely hot. If you’re not willing to slow the economy down with rate hikes, you may get short periods of very high GDP growth, but, ultimately, the economy’s going to come down to earth with a pretty big bang.”
Greenwest Consulting’s managing director Emre Akcakmak shared a similar perspective with the Financial Times, likening liraisation to “electroshock therapy.” Fitch Ratings also expressed myriad concerns as it downgraded its outlook for Turkey on 10 March.
“What is really worrying at the moment is this level of depreciation, this pressure on inflation. The concern is that it will cause a broader lack of confidence in the banking and financial system,” Ash said in the interview. “The world you see runs on banks, and that’s the game-changer for Turkey… if that happens, then Turkey is heading for a major systemic crisis.”
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