The sanctions Washington slapped on Ankara last week over its military operation in northeastern Syria failed to produce the currency shock that President Donald Trump had hoped for, drawing on last year’s precedent. In the summer of 2018, amid a row over Turkey’s detention of an American pastor, Trump’s Twitter outbursts and ensuing sanctions had a devastating impact on the Turkish lira. This time, however, Washington failed to trigger a serious turbulence and has already agreed to withdraw the measures in the coming days under a deal with Ankara, reached Oct. 17. Why did the threats and sanctions fail to produce the same impact this time?
The main reasons have to do with the contraction the Turkish economy has been undergoing for almost a year. The crisis has curbed imports, lowering the demand for hard currency, and savings holders had already put their money in foreign exchange against the volatility of the lira. Also, the shrinking economy has discouraged borrowing and the central bank has taken measures to fend off currency shocks.
In another tension-raising move last week, US prosecutors brought a criminal case against Turkey’s state-owned Halkbank for aiding a multibillion-dollar scheme to evade sanctions against Iran, charging that senior Turkish officials protected the scheme in return for kickbacks. Although the move hit Halkbank shares, it did not trigger a currency shock either.
In a brash letter to President Recep Tayyip Erdogan, Trump had threatened to “destroy” the Turkish economy, recalling the row over the Rev. Andrew Brunson. “You don’t want to be responsible for slaughtering thousands of people, and I don’t want to be responsible for destroying the Turkish economy — and I will. I’ve already given you a little sample with respect to Pastor Brunson. … Don’t be a fool!” Trump wrote in the Oct. 9 missive, widely seen as a diplomatic scandal to remember.
Judging by the letter and Trump’s similar threats on Twitter, the US president was apparently confident he could repeat the shock he had set off in Turkey’s economy in August 2018.
Let’s recall briefly what had happened at the time. On Aug. 1, 2018, Washington announced sanctions against Turkey’s justice and interior ministers over Ankara’s refusal to release the pastor, who was held on charges of links to the putschists behind the coup attempt in 2016. The move sent the Turkish lira into a tailspin that continued for days as tensions between Washington and Ankara simmered on. On Aug. 10, 2018, the currency lost about 17% of its value in a single day as Trump doubled steel and aluminum tariffs on Turkey, gloating that “the Turkish Lira slides rapidly downward against our very strong Dollar!” As of Aug. 10, the increase in the price of the dollar stood at 70% against the lira since the beginning of 2018, 37% over a month and 27% over a week.
The currency shock fueled inflation to up to 25% on a year-on-year basis, leading to a sharp decline in consumption and eventually an economic recession.
Hoping for a similar impact again, Trump fired threats and then authorized sanctions Oct. 14 in a bid to deter Turkey. Although the military thrust in Syria was not free of financial jitters, the lira fluctuated in the 5.7-5.9 region against the dollar, far from the record lows it had hit last year. Following the Oct. 17 deal, sealed during Vice President Mike Pence’s visit to Ankara, the rate eased to below 5.8.
A major reason for the different outcome this time is that Turkey’s current account deficit, standing at $31 billion in August 2018, had evolved into a surplus of $1 billion by August of this year — not because of some economic progress, but as a result of contraction. The Turkish economy is expected to shrink at least 1% this year. The current account surplus owes to a sharp decline in the demand for imported goods, combined with some uptick in exports and tourism, albeit at the expense of price cutting.
Also, savings holders in Turkey have already put about half their deposits into hard currency because of eroded confidence in the economy. As a result, banks appear free of any foreign-exchange liquidity problem. Furthermore, the economic contraction has curbed loan demand amid a standstill in investments and a decrease in production capacities. Because of the loan shrinkage, the rollover ratio of external borrowings has also fallen.
Additionally, the central bank has taken measures neutralizing the impact of the foreign swap market and thus precluding any foreign-exchange attacks. Foreign investors are no longer short-selling the lira.
In sum, the economic contraction that followed last year’s currency shock has cushioned the impact of any new ones. An additional shield has resulted from government moves such as imposing control over the central bank and forcing it to make decisions bending the rules and using public banks as tools, albeit at the expense of inflicting them with losses.
Trump’s decision to suspend talks aimed at boosting bilateral trade to $100 billion was rather irrelevant, too. Given that Turkey’s total foreign trade is worth $350 billion to $400 billion, the $100 billion target amounted to no more than wishful thinking in the first place.
Trump’s sanctions included also hiking tariffs on Turkish steel to 50%, but representatives of the sector appeared unimpressed. In remarks to Deutsche Welle on Oct. 15, Namik Ekinci, the head of Turkey’s Steel Federation, voiced doubts on whether the sanctions would be fully implemented. He recalled that Washington had raised tariffs on Turkish steel to 50% last year before retracting the measure. “They lowered the tariff back to 25% in May 2019 after bilateral talks. That they are now hiking the tariff again means nothing to us,” Ekinci said.
Trump’s sanctions may have not led to a currency shock and a big economic turmoil, but perceptions of risk vis-a-vis Turkey have heightened and the confidence crisis has deepened. Turkey’s risk premium, reflected in credit default swaps, has at times shot up above 400 basis points in recent days, sending warning signals to foreign creditors.
Turkey’s military operation in Syria has cost it also harsh reactions from the international community, from the European Union to the Arab League and China. The greatest damage is, no doubt, in ties with the United States, where Congress members have slammed the administration for going easy on Ankara. A bipartisan bill calling for tougher sanctions remains on the table after the Oct. 17 deal, under which Turkey agreed to a five-day pause in its offensive to let Kurdish militia withdraw from a border stretch controlled by Turkish forces.
How the deal will transpire remains to be seen, but the widespread outcry over the operation threatens to damage Turkey’s international standing in general. As a result, US and European companies and financial institutions might reconsider their dealings with Turkey at a time its economy needs foreign funds to recover and start growing again. German carmaker Volkswagen has already paused a major investment plan in the country.