Turkey. The country straddling both Europe and Asia last week reelected Recep Tayyip Erdoğan for another five years, the controversial president winning 52% of the votes in the nation’s first ever presidential run-off. 

As leaders from around the world moved to congratulate the president, markets were less gracious. The lira (USD/TRY) plunged to a record low, with 20 Turkish lira now required to buy one dollar. 

Why is the Turkish Lira falling?

Erogan’s determination to pursue low interest rates and loose fiscal policy is eroding the lira. The President asserted Monday that the central bank interest rate “has now been reduced to 8.5% and you’ll see inflation continue to fall”. He added that “if anyone can do this, I can do it”, with respect to the rampant inflation which has engulfed the state. 

Investors weren’t so buoyant, with lowered interest rates flying in the face of economics 101 – and exactly the opposite of what other nations around the world have done over the past 18 months. 

The government’s burning of foreign reserves appears unsustainable. The Financial Times reported that Erdoğan reduced foreign currency and gold reserves by $17 billion in the six weeks running up to the general election, a decline of 15%. That $17 billion is split between a $9.5 billion drawdown of foreign currency and $7.5 billion of gold (Turkey held 572 tonnes of gold at the start of the year). 

Updated numbers put the decline in total reserves at around $27 billion, constituting a fall of 24%. These policies are unconventional, to say the least. Authorities have also introduced capital controls as part of continued efforts to prop the lira up. Foreign currency access has been made difficult for Turkish citizens, while gold imports were suspended after February’s earthquake as retail demand spiked. 

This all comes as the current account deficit in the nation widens to near-record level (despite billions borrowed from domestic banks, serving to soften the optics on how large the deficit is). 

Further pressure on government finances comes through special savings accounts, which pay out a greater interest rate if the lira depreciates. The shortfall is made up by the government, with the accounts introduced in 2021 as an initiative to help protect the lira. There is currently over $120 billion in the accounts, with finance minister Nureddin Nebati saying the accounts had cost the country around $4.7 billion thus far. 

Turkish inflation remains elevated

Combined with the unconventional monetary and fiscal policy is the fact that the Turkish lira’s purchasing power is also eroding domestically. Inflation in the nation ballooned over 80% in Q4 of 2022 and remains above 40% on a year-over-year basis.

Simply put, something has to give. All the classic ingredients of an economic meltdown are here: unsustainable monetary and fiscal policies, as well as a volatile political regime. Concern is high regarding what policies Erdoğan will introduce next, as foreign reserves cannot continue to be drawn upon by the government, while he has stated publicly that interest rates will not be hiked. Again, something must give. 

Formal capital controls are the most obvious answer, and this is a route we have seen many regimes take in the past, notably Russia last year as they moved to artificially prop up the ruble amid pressure leveled by Western sanctions. 

Even still, fear is prevalent in Turkey that this economic mess will not be solved anytime soon. We saw last quarter in the US how quickly a bank run can occur; how long will Turkish investors hold the faith in a creaking regime? How much gold can the government sell? How much foreign currency can it offload?

It has been a turbulent few weeks for Turkey on the political side of things. Economically, it has been no less rocky. The future ahead is murky.  

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