Turkey’s government has taken fresh steps to keep exchange rates under control as a resurging dollar threatens to further weaken the Turkish lira, although such interventions erode confidence in the economy, which is still ailing after a big currency shock in 2018.
Few would disagree that controversial measures to shield the lira have meant a de facto departure from Turkey’s floating exchange rate regime over the past year. Foreign exchange rates have been regulated — or, rather, suppressed — through veiled interventions by the central bank. To keep the lira below six against the dollar, the central bank has often funneled foreign exchange to the market via state banks, using money that it could have kept as reserves. Such moves amount to political manipulation of foreign exchange prices, given the tight control the government has attained over the central bank since last year.
In a fresh step to that effect, the Banking Regulation and Supervision Agency (BDDK) announced Feb. 9 new limits to foreign exchange transactions. The agency cut the limit for Turkish banks’ forex swap, spot and forward transactions with foreign entities to 10% of a bank’s equity, a move that effectively aims to curtail transactions that could raise hard currency prices. The limit had already been halved to 25% in August 2018, when the currency crisis hit.
President Recep Tayyip Erdogan and others in charge of the economy under the Justice and Development Party (AKP) have blamed Turkey’s currency woes on foreign actors who allegedly mount speculative attacks on the market to send hard currency prices up in a bid to crash the Turkish economy and, by implication, take down the AKP.
As part of such narratives about Turkey being under threat, Erdogan has often urged citizens to stick to the lira and shun hard currencies. At a rally ahead of the March 2019 local elections, for instance, he warned “those in the finance sector” that they would “pay a heavy price” for any “provocative actions” on the foreign exchange market. “We know who you are and what you do,” he said. “The BDDK has taken certain steps, but you should know that we will present you with a hefty bill after the elections. You will not be allowed to exploit this nation.”
The depreciation of the lira brought about consumer inflation of up to 25% in 2018. Increased foreign exchange prices meant higher costs for producers and service providers, resulting in economic turmoil and eventually recession. This was the inevitable outcome of economic policies that emboldened hard-currency spending but did little to encourage hard-currency earnings.
In the first half of the AKP’s 17-year rule, Turkish companies took advantage of abundant global liquidity to borrow lavishly, and many appeared oblivious to the risks of repayment. As a result of the borrowing spree, the private sector holds two-thirds of Turkey’s external debt stock, which stood at $434 billion in September, amounting to nearly 59% of the country’s gross domestic product.
But the cycle of borrowing to repay debt ground to a halt as borrowing costs increased under the impact of global economic trends in recent years. Confidence in the lira weakened as foreign exchange prices increased, fueling a flight to hard currency. The trend came to a head in 2018, with the price of the dollar shooting up to 7 liras from the region of 3 to 4 liras in a short period of time.
The AKP government, however, refused to acknowledge the troubles as the outcome of its ill-conceived economic policies, arguing instead that it was the target of foreign plots. As a result, the BDDK reduced the swap limit for banks to 25% from 50% of a bank’s equity in August 2018, a move that was followed by measures to draw swap transactions from the London foreign exchange market, the world’s biggest, to the domestic one.
Such restrictions on speculative trading have been coupled with the central bank’s interventions via state banks to keep foreign exchange rates in check. The money the central bank has used in this way is estimated at $32 billion, a figure that has not been officially denied so far.
The BBDK’s Feb. 9 decision to further limit swap transactions followed the lira’s slide against the surging dollar last week. The fear in Ankara is the same — that speculative trading by foreigners would push hard currency prices up and put fresh strains on the economy.
The economy management feels compelled to suppress foreign exchange prices because it has failed to reverse the flight to hard currency amid a series of rate cuts that the central bank has made since coming under tight government control last year, despite inflation that has yet to be tamed. More than 51% of deposits in the country remain in foreign currency accounts. An intensified flight to hard currency would result in more inflation; hence, the flurry to keep foreign exchange prices in check.
The measures aimed at neutralizing “foreign conspirators” are in fact beneficial to foreign investors dealing in Turkey. Foreigners who bring in hard currency and convert it to liras to invest in stock shares or government bonds emerge more profitable when they exit the Turkish market, as they convert their liras to hard currency on the suppressed rates. Still, attracting investors is not that easy, as they perceive growing risks in a country where predictability has waned and political decisions have come to supersede market dynamics.
This is also true for foreigners in Turkey’s banking sector, where private banks, too, have felt the heat of Ankara’s impositions. As Al-Monitor warned months ago, foreign banks are reconsidering their investments in Turkey. Last week, UniCredit cut its stake in Turkish bank Yapi Kredi, while HSBC is reportedly considering exiting the country altogether.
The apprehension of the business community was tangible at the convention of Turkey’s leading business group, TUSIAD, last week. The chairman of the association, Simone Kaslowski, warned that “frequent changes in regulations in both the real sector and money markets, the abrupt and unexpected appearance of new laws for the business community and tax policy measures that shake the confidence of economic actors and raise concerns over property rights” were bearing adversely on the investment environment.
In sum, selling conspiracies to the public instead of acknowledging the realities is hardly a solution. An inevitable surge in foreign exchange prices is looming over the Turkish economy.