Turkey’s Lira is weakening as economists warn about ‘unsustainable policies’

Analysts warned that Recep Tayyip Erdoan’s reelection would put the country’s $900bn economy to the test.

Several economists believe that Erdogan’s policies low interest rates and emergency currency measures cannot continue, as Turkey’s currency reserves are rapidly declining.

After a holiday, trading in London, Europe’s main currency exchange hub, resumed on Tuesday.

Liam Peach, a London-based economist at Capital Economics, said that the current policy is unsustainable. “Turkey can’t continue to have very low interest rates and a very lax fiscal policy, nor can it burn through its foreign currency reserves.”

Turkey reserves dropped by around $27bn in this year, as the country tried to prop up the Lira and finance an current account deficit that was near record levels. According to official data, the total reserves, including gold and foreign currency, is just over $101bn.

According to JPMorgan, however, net reserves (a figure that subtracts liabilities) are effectively zero and deep negative when you exclude tens billions of dollars of money borrowed from local banks.

Clemens Graefe, an economist with Goldman Sachs, in London, stated that reserves are now “close to the levels at which lira volatilities sharply increased previously”.

Erdogan, who won the run-off election on Sunday with 52 percent, insisted that he would continue to maintain his policy of low interest rates, despite inflation currently exceeding 40 per cent.

He said, “If anyone could do this, then I can.” “[The main interest rate of the central bank] has been reduced to 8.5% and you will see that inflation also falls.”

He said that “eliminating price increases due to inflation and the loss in welfare are the most pressing topics for the next days”, but did not give any specifics. Investors are concerned that the $121bn equivalent in Turkish liras, which Turks have deposited into special savings accounts will be paid out by the government if the currency depreciates.

Nureddin Nebati said that the accounts have cost the country approximately TL95,3bn ($4.7bn), since their introduction in 2021.

If the lira drops faster in the coming weeks, then it could have a rapid impact on public finances.

Analysts say that Erdogan could still be able draw new funding from his allies in the Middle East, including Russia.

Last week, the president stated that Gulf countries who wished to remain anonymous had provided funds for stabilizing Turkey’s market. He did not provide any further details. Erdoğan would probably receive a short-term boost from summer tourist cash receipts that tend to ease strains on the country’s finances, said Wolf Piccoli at the Teneo consultancy.

The Bist 100 index in Turkey, which was boosted by locals fleeing high inflation, also rose more than 4% on Monday. Local investors have been boosted by the high inflation, as they seek to compete with rapid price increases.

Some economists believe that Erdogan will appoint an economic team that includes names well-known to foreign investors.

Ilker Domac, Citigroup, said: “With the election behind us all eyes will be focused on the composition and credibility of the first policy response.”

Domac warned that the central bank of Turkey would find it “increasingly difficult” to keep the interest rate below the inflation rate, “especially during the final quarter of the year”.

Some economists expressed a higher level of concern.

Atilla Yeşilada, a consultant at GlobalSource Partners in Ista, wrote: “Be prepared for the worst. This could include formal capital controls or serious deposits flight from the system.”