On Monday, Recep Tayyip Erdogan gave yet another speech amid the ongoing collapse in the Turkish lira and he stuck to the script, claiming the currency “will settle at a rational level soon” and blaming nefarious external actors for “attacks” on his country.
Measures undertaken by the Turkish central bank earlier in the session generally failed to stop the bleeding, offering only fleeting respite. The lira briefly trimmed losses when CBT lowered reserve requirements for the lira and for dollar liabilities, but the currency went on to trade back to the levels weaker than Friday’s lows. As Bloomberg’s Luke Kawa noted on Monday morning, 10-day realized volatility for the Turkish lira is now higher than bitcoin.
The lira turmoil rippled through emerging markets, sending the rand, the rupiah, the ruble and other developing nation currencies lower in its wake.
Analysts are still a bit incredulous, but have rapidly come to terms with the reality that is Erdogan and his readily apparent willingness to risk it all in defense of his honor.
The Turkish autocrat spent the entire weekend delivering paranoid harangue after paranoid harangue. On at least five separate occasions he repeated calls for Turkish citizens to trade in their dollars, euros and gold for lira. On Friday, reports suggested Turkish banks were struggling to keep up with demand for foreign currency, a sure sign that locals did not heed his calls.
On Sunday, Bloomberg was out with a new piece documenting the plight of Turks caught between a dictator and economic reality. Here’s what one 58-year-old retiree said when asked about Erdogan’s demands for currency conversion:
I have respect for our president, but I can’t sell my gold and foreign currency just because he made that call. I’ve cut down on food for those savings.
With all due “respect” to that poor soul, he might want to think about the relative wisdom of saying that on the record, considering the fact that Erdogan has thrown people in jail for a lot less than questioning the stability of the currency.
In any event, you should read that linked Bloomberg article, as it certainly seems to suggest that capital controls are already de facto in place. On Sunday, Erdogan rattled locals even further by saying this at his third rally of the day:
I’m calling out to industrialists, do not attack banks to buy FX. It is industrialists’ duty too to keep this nation on its feet. Otherwise we will set into motion our plan B and C.
As noted, that likely means draconian capital controls are right around the corner.
Or maybe not, because hours after Erdogan made those comments, Fahrettin Altun, communication head for the presidency, took to Twitter to “explain” that because Erdogan didn’t specify what “plans B and C” will entail, you shouldn’t extrapolate.
“Provided that the President did not reveal the details of plans B and C, it is unacceptable that certain people come up with fictive scenarios in order to unsettle the people and market players”, Altun said, adding this:
Turkey’s economy is strong and we will win this fight through the government’s cooperation with the people!
Now that’s a “fictive scenario”.
When it comes to capital controls, SocGen’s Phoenix Kalen is out with a great new note that tries to document Turkey’s options for “exiting the vortex.” Here’s Kalen’s list (and these are just the bullet points, she adds a lot of color in the full note):
- Blocking US usage of Turkey’s Incirlik air base
- Threatening to withdraw from the North Atlantic Treaty Organization (NATO).
- Announcing a debt moratorium on its sovereign liabilities.
- Approaching the IMF for financial assistance.
- Releasing Pastor Brunson immediately.
- Attempting to shore up market confidence in Turkey’s economic policy.
- Imposing capital controls.
- Relying on FX swap facilities.
- Waiting it out.
- Hiking interest rates by at least 600bp.
Suffice to say exactly none of those options are what one might call “palatable” and some of them simply aren’t realistic, something Kalen explicitly acknowledges.
In light of what’s happened since her note was published on Friday (i.e., considering Erdogan has ruled out an IMF program, suggested he’s not inclined to release Brunson, and quite literally said he’d rather die than hike rates dramatically), it probably makes sense to zoom in on the capital controls angle, at least until there’s some sign that Ankara is prepared to cede ground. Here’s what SocGen has to say about this:
One possibility under the capital control option is to freeze foreign currency deposit accounts and force conversion of foreign currency deposits into TRY. There is about USD 161bn of foreign currency deposits in the Turkish banking system held by corporates and individuals. In an extreme scenario, the conversion could occur at non-market rates (i.e. detrimental to those holding foreign currency). However, this could have the negative side effect of increasing the probability of corporate defaults on foreign-currency debt. With this said, we believe that capital controls are instruments of last resort, and Turkey has historically resisted implementing them. Furthermore, according to academic literature, capital controls typically have significant limitations: they need to target broad components of capital flows to have a noticeable macro-economic impact, they are less effective in well developed capital markets, their impact tends to fade quickly, and they can impair long-term growth.
Right. And therein lies the problem. The only “option” that allows Erdogan to cling to his pride would be exceptionally detrimental to market sentiment and could make things immeasurably worse for Turkey.
Additionally, it goes without saying that if he imposed capital controls, he would likely trigger an acute bout of risk-off sentiment across other EMs. While he wouldn’t care about that, it could boomerang on him and pile still more pressure on Turkish assets. Oh, and according to multiple reports, Berat Albayrak has been making the rounds in the Gulf trying to secure investments that would help shore up the Turkish economy. I’m not sure what kind of impact the imposition of capital controls would have on those discussions, but you’ve got to think the optics wouldn’t be great.
As far as the prospect of a rate hike is concerned, I think that’s out of the question because i) Erdogan wouldn’t countenance the kind of hike needed to arrest the slide in the currency, ii) even if he did, it would have a dramatic impact on growth, iii) it’s not even clear there’s a hike large enough to stop the bleeding.
What’s certain is that recent weakness in the lira is going to exacerbate the inflation situation which was already spiraling out of control. “Some local economists anticipate that headline CPI will surge toward 20% over the coming months, due to the recent exchange rate depreciation [and] given the size of the move in recent days, CPI heading into the 20-23% range does not sound unreasonable to us”, the above-mentioned Kalen writes.
Finally, SocGen notes that in addition to the reputational damage Erdogan would incur from accepting an IMF program, Washington’s influence would complicate matters given the diplomatic spat. “Conditionality (or even blockage) imposed by US’s sizeable influence over the IMF’s executive powers reduces the chances of Turkey having access to this financing channel”, the bank contends.
So I don’t know, it’s looking pretty bleak. But then again, at least Turkish stocks are cheap…