Explained: Why Turkey's lira is crashing and what it has to do with strongman Recep Tayyip Erdogan

The lira has lost more than 40 percent of its value against the dollar since the start of the year and the annual inflation rate has reached nearly 20 percent, quadruple the government's target

FP Staff December 03, 2021 07:41:36 IST
Explained: Why Turkey's lira is crashing and what it has to do with strongman Recep Tayyip Erdogan

File image of Turkish president Erdogan. Reuters

This week saw Turkey's lira plunging as low as 14 to the US dollar and hitting fresh lows against the euro.

The country is facing its worst currency crisis since August 2018, when the lira hit historic lows during a row with then US president Donald Trump.

But why is this happening? And does it have anything to do with Turkey's strongman President Recep Tayyip Erdogan?

Let's examine this further:

What happened?

The lira has lost more than 40 percent of its value against the dollar since the start of the year and the annual inflation rate has reached nearly 20 percent, quadruple the government's target.

Yikes.

Could you explain that in simple terms?

Sure. The Turkish minimum wage was worth around $380 in January and after Tuesday's volatility, it is now worth $224 based on a net monthly wage of 2,825.90 liras.

Why is this happening?

Because the Turkish central bank on 18 November cut its policy rate from 16 to 15 percent – the third such cut since September – despite rising inflation and a fast-depreciating currency.

Okay. But why is the central bank doing this?

In short? Erdogan.

Just last week the Turkish strongman declared that his country was in a "war of economic independence".

Erdogan, an outspoken opponent of high interest rates, has built his popularity on a reputation of forging strong economic growth and improving the income of families across the country.

He is notorious for his unorthodox belief that high interest rates cause inflation instead of helping tamp it down.

And he does a lot more than just talk. Erdogan has already fired three central bank chiefs over ‘policy disagreements’ over the past couple of years and dismissed three monetary policy committee members in October.

Reuters has reported, citing sources, that Erdogan ignored appeals in recent weeks, even from within his government, to reverse policy.

A central bank source said on Tuesday that the executive director of the bank's markets department, Doruk Kucuksarac, had left his post and had been replaced by his deputy, Hakan Er.

Kucuksarac did not immediately respond to a request for comment.

A banker who requested anonymity said Kucuksarac's departure was further evidence of an "erosion and devastation" of the institution after this year's mass leadership overhaul and years of political influence on policy.

What has Erdogan said about his policies?

The Turkish leader defended the policies in an address to the nation after a cabinet meeting.  "We see the game played by those over the currency, interest and price hikes ... and show our will to proceed with our own game plan," he said.

"We will emerge victorious from this war of economic independence with the help of Allah and our people."

In an interview with state broadcaster TRT, Erdogan said there was "no turning back" from the new policy direction.

"We will see that the interest rates will fall markedly and hence there will be an improvement in exchange rates before the elections," he said.

Erdogan predicted inflation would ease and the current account would turn to surplus next year.

"Some people are making efforts to make them seem weak, but the economic indicators are in very good condition," Erdogan said. "Our country is now at a point that can break this trap, there is no turning back."

"Turkey will not live in a trap of exchange rate, inflation and interest rates," he added.

What happened next?

A massive sell-off by nervous investors. Which brought the lira to its record low.

But Turkey’s economy is growing, right?

Yes. The country’s economy grew 7.4 percent year-on-year in the third quarter, according to official data released on Tuesday, boosted by retail demand, manufacturing and exports.

Erdogan and other government officials have stressed that while there may be price pain for a while, the monetary stimulus should boost exports, credit, jobs and economic growth.

So what’s the problem?

Economists say the depreciation and accelerated inflation, which is seen reaching 30 percent next year due in large part to the currency devaluation, will derail Erdogan's plan.

Virtually all other central banks are raising rates or preparing to do so.

November inflation data will be released on Friday and a Reuters poll forecast that it will rise to an annual 20.7 percent, the highest level in three years. read more

What do experts think?

The experts are deeply unimpressed with Erdogan.

Traders have finally been tipped over the edge and completely lost patience with the policies being carried out by the central bank," Craig Erlam, senior market analyst at OANDA, told AFP.

"There's a reason why central banks are independent and this is what happens when the divide is crossed. A perfect storm of politically driven monetary policy, a complete disregard for inflation and other central banks taking a more sensible approach," he said.

"Surely someone in the palace has the guts to tap Erdogan on the shoulder and say, 'hey dude, you really screwed up'," BlueBay Asset Management economist Timothy Ash said in an email to clients.

"'Admit you were wrong, move aside and let someone who knows what they are doing run the CBRT (central bank)'," he said.

"Monetary policy is likely to remain under political influence and not tight enough to significantly reduce inflation, stabilize the currency and restore investor confidence," said credit ratings firm Moody's.

"It's a dangerous experiment Erdogan is trying to run and the market is trying to warn him about the consequences," said Brian Jacobsen, senior investment strategist, multi-asset solutions at Allspring Global Investments.

"Imports are likely to rise in price as the lira falls, making inflation worse. Foreign investment could be scared away, making it harder to finance growth. Credit default swaps are pricing in a higher risk of default," he added.

"Investors are getting more and more nervous. ... It's a toxic brew."

Is Erdogan’s future in peril?

Possibly.

Analysts believe the blizzard of economic misfortunes in the country could put pressure on Erdogan as he prepares for 2023 elections amid signs of consolidation within the Opposition, which has so far failed to seriously challenge him.

With inputs from agencies

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