The financial crisis broke out in Turkey for cumulative reasons even before the emergence of the coronavirus pandemic. While the negative effects of the global pandemic will emerge during this summer in Turkey, the pandemic has destroyed government hopes and plans for economic recovery, albeit relatively, this year.
This paper looks into the reasons for the current Turkish lira crisis and the solutions available to the government to overcome it or manage it for a longer period.
An economic policy that started in 2002 with the AKP
Since its arrival in 2002, the Justice and Development Party (AKP) adopted an economic strategy based on supporting growth through local borrowing, supporting the services and construction sectors, and financing the deficit in the foreign trade balance and growth through external borrowing. This strategy, which was supposed to be “temporary” and whose important parts were to be adjusted to ease reliance on external borrowing, continued to this day without the implementation of the necessary substantive reforms thereon. Turkey faced the first real warning with regard to this strategy in 2011 with the start of the decline in the then Turkish lira value due to inflated foreign debts. However, what saved Turkey then again were the international economic conditions. Major central banks in the world cut interest rates to zero and moved towards financial expansion. This provided liquidity of foreign currencies in markets that rescued Turkey then and helped it proceed with its faulty economic approach by recycling foreign debts.
However, starting from 2011, the Turkish currency started to shake, becoming more sensitive to Turkish and international economic and political developments. The lira’s value became contingent on the availability of foreign finance to recycle debts, and its price began to fall whenever the government had difficulty in securing foreign exchange and external funding for any reason. This was glaringly attested by the fall of the Turkish lira value in the summer of 2018 to 7.24 liras per US dollar due to the arrest by Ankara of US pastor Brunson and the threat by US President Trump to destroy the Turkish economy, which practically led to a halt of foreign funding to Turkey and the collapse of the lira price.
At that time, the Turkish Central Bank managed, after the crisis calmed down politically with Washington, to restore the price of the Turkish lira to 5.15 liras per dollar within four months, through raising Turkish lira interest rate to a record 24 percent. However, the continued disagreements with Washington in 2019 and the direct interference by President Recep Tayyip Erdogan in Central Bank policies and the pressure he put for reducing the interest rate almost led to a new lira crisis had it not been for the renewed intervention by the Turkish Central Bank in an unprecedented and disturbing step for all foreign investors when it prevented, through the financial exchange channel SWAP, foreign investors from accessing the Turkish lira. Although it then saved the Turkish lira from a new blow, this step led to a loss of confidence by foreign investors in Turkey’s “integrity” in its financial dealings with investors.
An unrealistic, high-cost economic policy since 2019
In 2019, an economic plan was developed by the government of President Erdogan and his son-in-law Finance Minister Berat Albayrak, based on reducing both interest rates and inflation, driving economic growth to 5 percent, reducing the foreign trade balance deficit, and maintaining the value of the Turkish lira at 6 liras per dollar. These were promises that all economic analysts agreed were impossible to keep in Turkey, especially with the deterioration of Turkey’s foreign policies and its relations with Washington, the Arab World and the EU, and its dwindling chances of obtaining loans, funding or foreign investment because of those policies. Today, Turkey pays an extremely high price for this unrealistic economic policy.
Practically, the Central Bank started in July 2019 to gradually reduce interest rate, from 24 percent to reach 8.50 percent beginning of May 2020. This was done based on direct orders from President Erdogan as the Central Bank completely lost its independence. Low-interest loans in Turkish liras were pumped from government banks to support growth and new projects and save projects nearing bankruptcy. The government sought to interfere and manipulate inflation figures to show them lower than they really are.
With the continued deterioration in the economic situation in Turkey and the decline in foreign investments and foreign funding due to the decline in confidence in President Erdogan’s government and foreign policies, the Turkish Central Bank had to interfere monthly to support the Turkish lira and fix its price against the dollar. It even had to dispose of a total of 65.7 billion dollars from its foreign exchange reserves between January 2019 and March 2020 to support the lira in the local market and fix its price at 6 liras per dollar. This led to a serious and unprecedented decline in the reserves of the Turkish Central Bank. The Turkish government and the Central Bank rely on non-transparency to cover up this truth that the financial analysts can calculate. The greatest evidence of this serious decline is the recent loss by the Central Bank (in May 2020 specifically) of its previous capability to interfere and pump dollars into the market to protect the value of the lira as it used to do. This again led to an accelerated collapse in the value of the lira to 7.24 liras per dollar.
Currently, the failure of the economic policy developed by President Erdogan in 2019 can be announced. That policy would drive Turkey to a severe funding crisis in addition to its economic crisis and the recession that had started in 2018. All this coincides with the coronavirus epidemic which ended any hope the government still had to drive growth, albeit at the expense of foreign savings. All attempts by the Turkish government have failed to access funding or foreign investment to protect the lira value or close the deficit in the foreign trade balance. Now, the government, the Turkish financial market and the private sector all face an uncertain and serious future depending on the steps that will be taken by the government to come out of this crisis as soon as possible in the coming weeks till July when the financial situation is expected to explode with the need by many Turkish companies for foreign exchange to repay their foreign debts due this year, estimated at nearly 170 billion dollars. In case the situation remains unsolved, the Turkish lira will experience a significant deterioration in the summer of this year the size of which cannot be guessed but which will transform Turkey into a new state similar to what was experienced earlier by Argentina.
Traditional solutions put forward
Turkey has been used to four traditional solutions in similar crises. However, all those solutions face political and operational obstacles that prevent their implementation currently. Those solutions are discussed below:
First, raising the interest rate: this is one of the most important traditional solutions for saving the price of the Turkish lira. However, due to the ideological orientation of President Erdogan and Finance Minister Albayrak who insists that raising interest rate will hinder Turkey’s economic plans to drive growth, this solution is not under consideration, currently at least, because it would amount to a recognition of the failure of the economic plan developed in 2019 and a recognition of the failure of the economic theory developed by Erdogan himself that it is possible to reduce interest rate and inflation together in Turkey.
Second, gradual withdrawal of the Turkish lira from the market by the Central Bank for reducing supply of the lira and raising its price. However, this solution also seems impossible with the focus by the government on saving companies and driving growth by offering low-interest loans through government banks and allocating 100 billion liras in compensation for losses of tradesmen as a result of the lockdown during the coronavirus pandemic period. While the amount was subsequently raised to 200 billion liras, economic analysts say that what has been spent so far does not exceed 20 billion liras because of the government’s financial deficit, and that the funds offered have been printed by the Central Bank without value.
Third, selling more of the Central Bank dollar reserves: Minister of Finance Berat Albayrak said in a meeting with foreign investors in the first week of May 2020 that the Central Bank has a foreign exchange reserve, but he did not provide any figures, given that Central Bank figures indicate that its current total reserves of foreign exchange and gold in May 2020 are nearly 86 billion dollars, although it is known that of these, 59 billion dollars belong to Turkish banks as mandatory deposits in the Central Bank, and the Central Bank cannot use them because they do not belong to it. Therefore, the Turkish Central Bank’s real net foreign exchange reserve is 27 billion dollars only, all of which came through SWAP agreements with governments and foreign banks that have to be re-paid within this year. Therefore, upon deducting the total foreign exchange that has to be repaid by the Central Bank upon completion of the SWAP agreements this year, the Central Bank’s real foreign exchange reserve would be equal to -2 billion dollars. Thus, the Central Bank’s capability to offer more hard currency in the market to protect the lira value has weakened considerably. So, the Turkish government has started to put pressure on private and foreign banks operating in Turkey to help it obtain loans and foreign investments or deposit more of their customers’ foreign exchange deposits with the Central Bank. The Turkish Banking Regulation and Supervision Agency (BDDK) has threatened private banks operating in Turkey with large financial sanctions (reaching 500 million liras) for banks that do not cooperate with the Turkish Central Bank. While this pressure step could have limited and short-term results, it will widen the confidence gap between foreign banks and the Turkish government.
Ironically, and to demonstrate the confusion characterizing the management of the Turkish economy, the Turkish Banking Regulation and Supervision Agency, which also reports to President Erdogan although it purports independence in its decisions, imposed sanctions on three foreign banks, namely US Citibank, Swiss UBS and French BNP Paribas, by banning them from dealing with Turkish banks. This decision came in the morning of 8 May 2020, given that Finance Minister Berat Albayrak had an appointment to hold an online meeting with dozens of foreign bank representatives and foreign investors to invite them to invest in Turkey or strike SWAP deals with the Central Bank, and that the invitees included representatives of three banks that came under sanctions that morning.
Fourth, resorting to the International Monetary Fund (IMF): this is a step that is resorted to by many of the countries in Turkey’s current position. However, this has become extremely difficult in light of President Erdogan’s ideological policy and his adamant rejection of this step as it constitutes a recognition of the failure of all his economic policies and of those of his party that boasts about having repaid all of Turkey’s debts to the IMF and ended all dealings with it. Furthermore, due to the tension in relations between Ankara and Washington, it would be difficult for Turkey to strike a stand-by arrangement with the IMF, even with Erdogan’s approval, because Washington has the right to veto any agreement to be signed by the IMF, being its largest founding partner. Even if Turkey resorts to the IMF to request urgent support due to the coronavirus pandemic (an urgent support that Washington cannot obstruct), that support would be limited (between 3.2 and 9.5 billion dollars only). So far, Turkey has not taken steps to apply for such support. Considering that Turkey’s total debts in 2019 reached nearly 437 billion dollars, of which 169 billion dollars are due this year, including a private-sector share of 71 billion dollars, the funding or loan needed by Turkey far exceeds what it can get from the IMF on the pretext of the coronavirus pandemic. In fact, Turkey needs a loan of 60-80 billion dollars to come out of its current crisis.
Non-traditional solutions put forward
The government of President Recep Tayyip Erdogan rejects any economic solution to the current crisis that would harm growth or raise interest rates on the Turkish lira. It also rejects resorting to the IMF. However, the lack of financial and economic stability in Turkey will obviously affect its political structure. In order to come out of the current crisis, the government of President Erdogan believes that it has to take two important steps: promptly come out of any economic lockdown due to the coronavirus pandemic regardless of the health or social cost, and finding external funding, albeit limited, to delay or prevent a major collapse in the Turkish currency over the next six months. That is, the government is looking for temporary rather than radical solutions as President Erdogan still believes that he can revive the Turkish economy and drive growth once more and that this was only prevented by the advent of the coronavirus crisis. He views the situation as an incidental crisis whose effects can be overcome by cutting short the economic lockdown period and finding external funding that protects the Turkish currency pending the re-activation of the economy within a period that Erdogan believes will not exceed six months or the end of this year at the latest.
In fact, all the non-traditional solutions that will be explained here depend mainly on obtaining support from Washington and London. That is why President Erdogan has to improve his country’s relations with the West, in general, and with Washington, in particular, at the current stage. Interestingly, the Turkish authorities referred to the coronavirus pandemic as a pretext for not activating the Russian S-400 missiles last April, unlike earlier promises by President Erdogan and Defence Minister Hulusi Akar. This is an important step to appease the US Congress and the White House. The non-traditional solutions are as follows:
First, striking a SWAP agreement with the US Federal Reserve (the Fed) or one of the central banks of major industrial countries: such an agreement worth 10 billion dollars could provide the Turkish Central Bank with support for the Turkish lira value over the next six months, pending exit from the implications of the coronavirus crisis ‒ as believed by Erdogan according to his own calculations ‒ although this would not solve the crisis of the Turkish economy or the foreign debt crisis. Fed officials have confirmed that Turkey is not one of the countries included in the Fed SWAP list. On the other hand, Turkey seeks to convince central banks in Japan, Germany and the UK to sign SWAP agreements with Turkey, although this seems to be difficult under a US veto. Turkey had recently signed two SWAP agreements, one with China for one billion dollars in 2019, and the other with Qatar for 5 billion dollars in 2018, but it failed to expand or increase the value of those agreements. Turkey also received a “zero deposit” worth 4 billion dollars from the Libyan Accord Government at the beginning of this year. It would be difficult to obtain again a similar amount from the Libyan government soon.
Second, changing the rules of the financial game and investments in Turkey: this is a painful and difficult option as the Turkish government will have to impose new laws preventing the exit of the dollar from Turkey or transferring it abroad, or impose substantial taxes on foreign investors to force them to refrain from withdrawing their deposits or investments (from the beginning of the year till the end of last April, nearly 7 billion dollars of foreign investments exited Turkey). Both the Turkish Banking Regulation and Supervision Agency and the Central Bank can impose these new rules and laws, although this will harm Turkey’s economic reputation internationally and aggravate its confidence crisis with the financial and economic institutions abroad.
Third, benefitting from the Turkish Sovereign Fund that was established by Erdogan in 2016 and has at its disposal most Turkish national companies or what remains of their shares in the government’s possession. The Fund is not accountable to any regulatory authority inside or outside Turkey. Therefore, President Erdogan and his government can obtain a high-interest foreign loan by using any of the Fund’s government companies as collateral, privatizing that company or selling it. However, the privatization or sale processes take a long time and will have to be disclosed by Erdogan. On the other hand, a foreign loan can be obtained secretly by using one of those companies as guarantor or collateral. This also would be extremely costly and would need green light from Washington due to the loss of confidence by many banks and financial institutions in the actions of President Erdogan’s government.
As was mentioned earlier, President Erdogan’s plans are based on seeking to overcome the current crisis which he considers temporary for six months. He hopes for the return of growth in Turkey and the return of foreign investments once again after the cut by major global and central banks of interest rates to zero and the search by investors for new countries to invest in. Erdogan will seek to attract those investments and funds once again by rushing to “normalize” economic conditions in Turkey and end the lockdown, claiming that Turkey has completely overcome the coronavirus crisis and that its economy has recovered to encourage foreign investors to return to Turkey.
In case the Turkish government does not find a solution to the lira and foreign funding crisis soon (within almost two months), the Turkish lira will face a new crisis that could lead to the collapse of its value to 8.5 liras per dollar. If the current situation persists without change, more companies will go bankrupt after failing to repay their foreign debts because of this dollar price, economic recession and the coronavirus pandemic. This would aggravate the crisis of unemployment which exceeded 14 percent before the coronavirus crisis.
This situation will have negative implications for banks whose non-performing loans (NPL) have increased. It will also have significant implications for the political situation and the government’s stability. Thus, the it appears that the Turkish government will have to offer diplomatic concessions in foreign policy, particularly in its relations with Washington and London, to find a solution to its current economic crisis.
EPC | 14 Jul 2021
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