The Turkish government is running out of options to tackle the collapsing lira, some analysts and economists said. The currency had lost nearly 20% of its value since the start of 2020 and hit its weakest point at 7.36/USD at one point on August 7. The last time Turkey experienced a major currency crisis was just two years ago, which was caused by US sanctions.
During that time, the currency temporarily stabilised after the Central Bank of the Republic of Turkey (CBRT) hiked interest rates by 625 bps. Since then, the lira has been on life support while the country’s economy has continually struggled. Now, the COVID-19 pandemic poses an even greater threat to Turkey’s emerging economy.
The OECD forecasts that imports from advanced economies would contract by 60% this year, which will create a dramatic impact on emerging economies such as Turkey. These countries cannot roll out huge stimulus packages as the health crisis prompts massive capital outflows. Decreased external finance will likely cause a balance-of-payments crisis for countries which regularly record current account deficits such as Turkey, which will, in turn, deteriorate investors confidence.
Morgan Stanley analysts categorise Turkey, along with India, Indonesia, Brazil, and South Africa as “fragile five,” a club of countries which grow too dependent on foreign investment to propel their growth. The political landscape in Turkey also complicates the matter even further.
President Recep Tayyip Erdoğan believes that high interest rates cause high inflation, which is contrary to widely-known conventional economic theory. Therefore, the CBRT will unlikely to raise borrowing costs to defend the currency as it did two years ago. Erdoğan has also long told the Turkish people that the country will no longer seek assistance from international institutions like the IMF.
For the medium term, Turkey may stabilise investment flows through capital control, but there is no guarantee it will be effective during a currency crisis. Turkish ability to continue buying the currency using national foreign-exchange reserves is also questionable because its foreign reserves are almost depleted.
