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Not Your Typical Currency Crisis in Turkey

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By Hussein Khattab, CFAPortfolio Manager, Eaton Vance Management

Boston - Turkey President Recep Tayyip Erdogan has a major, long-running bet on the power of lower interest rates to stimulate the economy, in the name of religious beliefs and "Turkish economic independence." Most recently, the central bank, now firmly a politically dependent institution, has cut rates 500 basis points since September, even as inflation soars. Since the central bank started cutting rates in September, the lira has shed approximately 50% of its value versus the dollar as of December 17, 2021.

According to latest data, gross reserves stand at around $130 billion, with approximately $60 billion coming from swap deals. However, net reserves stand at around negative $35 billion. The central bank is effectively defending the currency with reserves it does not have — a situation that cannot be sustained indefinitely. The central bank sold at least an estimated $5 billion worth of foreign currencies in this round of intervention.

Foreign portfolio investments in Turkey are at a record low, especially following the March 2020 purge of the market-friendly central bank governor. Local economic agents in Turkey — households and corporates — will drive local asset prices in the country. Erratic policies, the ever-increasing volatility in exchange rates, and unanchored inflation are risks that could not only lead to uncontrolled dollarization but also to the loss of confidence in the whole banking sector. One can only hope that policymakers in Turkey will change gears before the Turkish saver runs to the bank.

In recent months, Erdogan has purged the few remaining officials of the central bank and finance ministry who dissented from his policies. He is unwilling to compromise on his misguided views on monetary policy and appears more defiant than ever in the face of the latest currency crisis. This trajectory could lead to further civil discontent and a balance of payment crisis that could nudge the country into wider political and social instability. Elections are not until June 2023, but given how quickly the situation is deteriorating, the possibility of them happening earlier becomes increasingly likely. Regardless of when they occur, they will be a monumental decision for the country.

Over the past five years, we have seen multiple currency crises in Turkey. Periods of unorthodox monetary policy implementation and credit-fueled growth have, in every single instance, led to high inflation and a weaker currency. The playbook always had some form of a policy U-turn under the pressure of market moves and local economic agents. This time around, it is not clear if or when we will see such a U-turn and whether it will come in time to sufficiently reverse the damage done to the economy.

Bottom line: Erdogan is doubling down on an unorthodox monetary policy that has failed to deliver. We will be watching closely for signs of further fiscal, monetary and social stability deterioration that could ultimately lead to the loss of confidence in the banking sector. Any U-turn in policy should be closely scrutinized for its sustainability.

The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness.