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Weapons of Mass Destruction (WMD)

Turkish Currency Woes Put Erdogan in Tight Spot in Re-Election Bid

By Dorian Jones May 14, 2018

The Turkish lira is increasingly under siege amid mounting international investors' concerns. The publication Monday of unexpectedly poor economic data saw the lira approach record lows. The increasing financial turbulence comes as opposition parties begin to narrow the gap ahead of the June 24 presidential and general elections and voter concerns over the economy grow.

"We are in such a knife-edge situation," said analyst Atilla Yesilada of Global Source Partners. "There is extremely fragile sentiment toward the lira. Sentiment is negative for emerging markets in general and in particular for Turkey. Investors smell blood and they are going to keep coming after the Turkish lira unless significant counter steps are taken."

With double-digit inflation, investors have increasingly been warning the Turkish economy is overheating. In the last year, the government has spent billions of dollars to boost the economy in a process that has accelerated with elections. With opinion polls indicating a galvanized opposition narrowing the lead, President Recep Tayyip Erdogan has announced 2,000 lira (approximately $460) payments to all pensioners, at a cost of $5 billion.

International investors are pressing for a substantial increase in Turkish interest rates to support the lira and help to cool down the economy; but Erdogan Friday appeared to rule out such a move, describing interest rates as the "mother of all evil." He pledged that Turkey will "emerge victorious in its fight against interest rates" after the June elections. On Sunday, he repeated his message before flying to London for a three-day visit.

Erdogan adheres to the unorthodox economic view that interest rates cause inflation instead of reducing it. While the Turkish central bank is ostensibly independent, there is an awareness that the president has the final say.

"It's always difficult for the central bank to substantially raise rates given very strong political opposition and very shortly, before the election, it will be very difficult," said economist Inan Demir of Nomura International Plc.

"But the costs of a rate hike will be much lower than letting the currency depreciate. Unless this happens, the likelihood is the currency will depreciate further and possibly lead to a slowdown in the economy," added Demir.

Economic concerns are cited as the No. 1 issue of concern in many opinion polls.

"People are hungry and angry," analyst Yesilada said. But a major interest rate increase would bring financial woe to the large numbers of voters with big credit card debts. "It's an issue no one is talking about, but we have an explosion in credit card debt in Turkey," political columnist Semih Idiz of Al-Monitor website said.

Turkey's indebted construction industry, the major driver of the economy, would also, analysts warn, be hit hard by interest rate increases.

"Construction is a magnet industry, in the sense that it draws input from various indigenous industries, and it's labor intensive. When construction stops, recession spreads," analyst Yesilada said. "Construction companies are usually loyal supporters and contributors of the ruling AKP, so to lose their favor just before an election is not a good idea."

An increase in borrowing costs would likely hit demand for new housing. Construction companies are already struggling to sell existing stock, with reports many firms are close to defaulting on bank loans. Analysts say construction company debts account for more than 10 percent of Turkish bank loans.

Erdogan's opposition to interest rate increases could be tested further. On Wednesday, a New York court is set to sentence Hakan Atilla, a senior executive of Turkey's state-owned Halkbank, on Iranian sanctions violation charges. Atilla's sentencing opens the door to potential multibillion dollar fines on Halkbank and other Turkish banks, a prospect that analysts warn could further unnerve investor concerns over Turkey, leading to further currency falls and more pressure to increase rates.

Investors are also increasingly focusing on the outcome of the June election and the potential for political deadlock if opposition parties form the next government and Erdogan is re-elected.

"The scenario markets would dislike most is a divided presidential parliamentary power scenario. That would create more uncertainties for the markets. I think the markets will watch the opinion polls with an eye on that possibility," economist Demir said.

Turkey's central bank is due to meet next month, and there is the expectation it may raise rates modestly. Analysts say that with Erdogan aware of the tightening polls, he will likely seek to perform a delicate balancing act in averting a currency collapse without a major rate increase before the elections.

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