Turkey at the last exit before the currency crisis

“Legacy of 20 years of Erdogan's rule has reached a stage that can only be recovered after a long marathon”

On the infamous December 20-21 of last year, the Foreign Currency Protected Deposit (KKM) was introduced to curb domestic demand for foreign currency triggered by early interest rate cuts. Adjustment after adjustment was made to make the KKM scheme attractive for domestic individuals and companies, and companies could only be convinced to participate by granting significant tax advantages. At the time, the share of foreign currency in total deposits was at a peak of 67% and the USD/TL was at a historic low of 17.5.

In the past seven months, the share of foreign currency and KKM-indexed deposits in total deposits is higher today at 74%. The USD/TL is at the same level at 17.5. For a convincing account of how the KKM "prevented" the depreciation of the TL, I suggest you read Kerim Rota's article on how the famous $128 billion sale exceeded $170 billion. By the end of the seven-month period, the success of the AKP (Justice and Development Party) economic administration under the banner of "liraization" in this process, in which a significant portion of tax revenues were misused and transferred to depositors, is exactly "zero". With the realization that the miracle of the KKM, which was supported by steps such as the compulsory transfer of 40% of foreign currency earnings of exporting companies to the Central Bank and the manipulation of reserve requirement ratios, is nearing its end, the effect of the new measures taken by the Banking Regulation and Supervision Agency (BDDK) about 15 days ago has also faded. It is almost certain that the President’s army of advisors will be scheming to come up with new tools to postpone the risk of early elections triggered by the currency crisis. However, as the latest BDDK steps show, we have entered a period in which the impact of new interventionist measures, called "macro-prudential" measures, on the TL is limited to days, let alone stabilizing financial markets.

At the root of all this deterioration is the monumental misstep of monetary policy. Foreign exchange sales to limit the depreciation of the Turkish lira as long as we insist on real interest rates exceeding minus 60%. As can be seen in the graph below, the Central Bank of the Republic of Turkey's reserves (net of swaps and Treasury foreign exchange) have been spent to the hilt and the net foreign exchange position has now reached -$64.2 billion, exactly as it was during the currency crisis in December 2021. This incredible level of "foreign exchange shortage" as of July 2022 comes at a time when tourism revenues are heading for a peak, 40-70% of exporters' foreign exchange earnings are being compulsorily transferred to the Central Bank, and companies are forced to exchange their foreign currency to get loans.


The situation is dire. Moreover, the actions of the world's two largest central banks over the next 12 months will not only shake the heavily damaged Turkish economy, with foreign exchange reserves amounting to -$64 billion and consumer price inflation at 78% (for now). While it will affect all economies of the world, it will mainly put pressure on developing economies. Central banks that do not hedge their currencies with interest rate hikes will witness exchange rates spiraling out of control in their countries. The central bank Fed, alarmed by the 9.1% annual inflation rate in the US in June, which was much higher than expected, is only days away from raising interest rates by one full percentage point, up from the 25 basis points it started with in March. Until the much-discussed recession knocks on the door, the fact that the Fed will combine front-loaded rate hikes with the balance sheet contraction process will result in the Dollar Index, which was 95.6 at the beginning of the year and has appreciated to 108.5 today, moving towards the 110.0s last seen 20 years ago. Just this week, we have witnessed the euro, under the auspices of the European Central Bank (ECB), which seems unable to keep up with the Fed's monetary tightening pace, despite the fact that it will raise interest rates to lower euro zone inflation, which has reached the 8-9% range, losing 12% of its value since the beginning of the year and coming to parity against the dollar. In this environment where the Fed is blowing a storm into the dollar, we will witness the Euro / dollar heading towards 0.90 levels. Let's turn to Turkey.

It is clear that the government's economic policies are collapsing. Even if the elections are held in 2023, it seems that there is no room for maneuver in reducing inflation, alleviating worsening living conditions, narrowing the current account deficit and attracting foreign investors with moves to increase foreign exchange reserves; in short, in achieving economic stability. What remains is to keep growth "alive" by all means possible, regardless of the other macroeconomic imbalances it creates. In this way, at least come election time, the government can hope to remain in power without having to deal a major blow to unemployment. For months now, we have been watching the results of numerous polling firms to see whether these calculations are working for the AKP despite the lack of policies that would lead to a general increase in economic welfare. We will of course continue to watch during the election countdown. However, the presidential regime, with its decision to go to the elections by inflating growth and not allowing unemployment to spike, and not backing down from its mindless monetary policy in the meantime, is taking on significant economic risks. Perhaps in a way that has never happened before in the history of the Turkish economy.

Fitch, which downgraded Turkey's sovereign rating on July 9, the day the holiday started, from non-investment grade bad to even more bad, issued important warnings on July 14. When the President, his advisors and the people he has put in charge of the economic departments start to blame the crisis on the Turkish lira, which they will interpret as an attack by foreign powers during the election countdown period, they will surely regret that they did not listen to the harsh realities of the statements made by Fitch and others like it. Because Fitch warns implicitly: The risk posed by the complex policy actions taken to avoid raising interest rates, fuel growth and simultaneously keep the Turkish lira under pressure is the risk of a currency crisis. In other words, a paralysis of the economy when the economy reaches a stage where there are no foreign currency assets left, no matter how much the TL depreciates. Fitch forecasts that average annual CPI (Consumer Price Index) inflation will rise from the current 44% to 71.4% by the end of 2022, sounding the alarm that the TL will further depreciate in the remaining months of the year. In the warning statement that followed the downgrade, Fitch is even more explicit: rising inflation and the cost of financing, accompanied by increasingly interventionist and unpredictable economic policies, have significantly increased projected debt repayments, moving Turkey towards a crisis linked to public finances and the public foreign currency position. It also explains why the risk premium CDS has tripled in the last seven months to around 900 and will not fall. 

Seven months ago, the relief that would have been felt quickly with a change of government and a balanced economic recovery that could have been realized in a reasonable period of time, has now reached a stage that can be measured in years, even with a change of government. It is true that a change of government is a sine qua non for economic recovery. But the economic devastation that is the legacy of 20 years of Erdogan's rule seems to have reached a stage that can only be recovered after a long marathon.

*She is an economist with 28 years of professional experience and a columnist on economy/politics on web-based media. She was the Director of Research and Strategy at Egeli & Co. Asset Management, previously was the Turkey Economist of UniCredit Menkul Değerler A.Ş. as the Director of the Research Department; the Chief Economist and the Manager of the Research Department at Ekspres Invest; the Economist at Raymond James Securities; and Ege Invest; an Analyst of the Research Department at Global Securities, and Karon Securities. She received her undergraduate degree in Business Administration from Middle East Technical University in 1995, before receiving her M.A. degree in Economics from Hacettepe University.
She is the mother of a lovely daughter and runs the family farm producing raisins and grains in the city of Manisa/Saruhanli, located in western Turkey.

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