Desperate Times: Erdogan’s Scheme To Avert A Bank Run

“Never seen a day like this.”

That’s how one EM veteran described Monday’s rollercoaster ride in the Turkish lira.

I long ago gave up on the notion that investors of any kind would ever admit the truth about Turkey under Recep Tayyip Erdogan. As I put it last week (and countless times previous), there’s a lot of political utility in fighting a quixotic, never-ending battle against an amorphous cabal of purported conspirators, both foreign and domestic, both real and imagined. That’s right out of the autocratic playbook. It’s a tried and true strategy for taking power and holding onto it.

Read more:

‘Wild Madness’: Erdogan Takes Lira On Insane Ride

Stocks Collapse In Turkey As Lira Meltdown Sparks Panic

Lira Bleeds Out As Erdogan Pushes Currency Into Abyss

Market participants regularly describe Erdogan’s economic policies as a manifestation of “unorthodox theories” about the interplay between interest rates, FX and inflation. But that’s not what’s going on. As one Turkish lawmaker put it Monday, “there is no economic model — he’s trying to create conflict.”

Failing to internalize that simple message leaves EM investors perpetually incredulous at Erdogan’s purported “commitment” to policies that erode confidence in the lira. Again, there’s no such commitment. Erdogan is simply melding classic autocratic diversion tactics with run-it-hot fiscal policies. That’s it. It’s that simple.

History is replete with examples of autocrats employing bankrupt policy prescriptions and equally bankrupt ideologies for the purposes of political expediency. Eventually, they bankrupt their countries — literally. That’s what’s happening to Turkey.

Analysts spilled gallons of digital ink Tuesday in an attempt to explain the implications of the new measures Erdogan announced Monday, including and especially the plan to protect lira deposits from currency depreciation. The short version is just that the Treasury is on the hook for any depreciation in excess of interest paid on local currency deposits with maturities of three to 12 months.

Let’s start with what could go right. If the market doesn’t challenge Erdogan and the lira stabilizes, he’ll succeed in stemming a currency crisis without actually doing much. Assuming depositors convert hard currency deposits back into lira (comforted by the Treasury guarantee), spot would move further away from the Treasury’s “strike” price (if you will), further bolstering confidence and incentivizing more depositors to hold lira in a virtuous circle.

As for what could go wrong, the short answer is “a lot.” Most obviously, the market could push the issue. If the lira depreciates rapidly, Erdogan would be compelled to choose between hiking rates, intervening at the cost of further reserve depletion or watching as Treasury piles up losses. Assuming those losses are covered by freshly-minted lira, Erdogan’s scheme could exacerbate inflation.

“Arguably this is just fully dollarizing the deposit base. It’s either going to be in FX or now FX linked,” Tim Ash wrote, in a good blog post published on Substack Tuesday.  “[It’s] also kind of dollarizing the sovereign balance sheet,” Ash went on to say, adding that “with TRY2 trillion in lira deposits, the scheme likely costs the budget 1.5% of GDP for each 10% devaluation beyond the 14% deposit rate.” Ash said he could “easily” see the budget deficit doubling next year.

In a Monday note, TD’s Cristian Maggio conducted what he called a “thought experiment” detailing how things might turn out for Turkey under a scheme that guaranteed to compensate depositors for depreciation-linked losses above a certain threshold for USDTRY. “Our preliminary conclusion is that the bill for the government can easily turn out gigantic and, therefore, unsustainable,” Maggio wrote.

While he made a variety of specific assumptions that may or may not be applicable depending on how things turn out, I think it’s fair to say that Maggio’s overarching point stands. He posited two possible outcomes. “Either the bill for the government is too large to sustain, which would push USDTRY back on an upside trajectory or the compensation is small enough to limit the risk of over-indebting the government, but too small to be relevant for FX stability,” Maggio said, adding that “unless it works quickly and in a stable manner (which would reduce the cash cost for the government by limiting its burden to a guarantee only), disbursements will soon saddle the budget with extra, large-scale and unproductive debt.”

On Tuesday, Turkish stocks plunged again, tripping circuit breakers for a third consecutive session (figure below). Bloomberg’s Justin Carrigan offered an incisive take. “The Borsa Istanbul has been on a tear since mid-October, ostensibly as Turks piled into stocks, especially exporters, as a hedge against the currency’s losses,” he wrote. As such, it’s possible that falling stocks are actually a good thing — “a sign that demand for protection from further lira depreciation is softening,” as Carrigan put it.

However, it could also be evidence of wholesale investor abandonment. If that’s the case, it’s “only a matter of time before that sentiment seeps back into the currency market,” Carrigan concluded.

Finally, I should tip my hat to Tim Ash for detailing the political ramifications in the above-linked blog post.

“This scheme likely has bought time and avoided an immediate crash in the banking sector but it has done nothing to fight inflation, will further extend Erdogan’s unorthodox interest rate policy and likely puts off early elections and increases the chances of an Erdogan win,” Ash wrote.