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Turkey needs a new approach to the lira

Coronavirus has starkly exposed many countries’ existing weaknesses. In Turkey’s case, it has only exacerbated the longstanding problems of a chronic current account deficit, high inflation and a president who is opposed to moves to raise interest rates to tame either. The country has long been numbered among the “fragile five” group of emerging markets that were vulnerable to capital outflows. Now, however, Ankara’s attempt to prevent its currency from falling, which would narrow that deficit, risks pushing the country into a financial and balance of payments crisis.

Recep Tayyip Erdogan, Turkey’s president, cannot confound the basic laws of economics. His policy appears to be based on the mistaken idea that the country can have the “impossible trinity” of a pegged exchange rate, free-flowing capital and an independent monetary policy. Instead, the moves taken by him and his son-in-law Berat Albayrak, the finance minister, risk negative consequences for the economy and for Turkey’s citizenry. 

Neither can authoritarianism substitute for sensible economic policy. Attempts to bully and intimidate foreign investors by placing sanctions on foreign banks and banning speculation will only make Turkey a less appealing destination for the investment that it badly needs.

Even as the dollar weakened this week, the Turkish lira fell to a two-and-a-half month low against the US currency. The lira had already come under pressure against the euro — falling to a record low against the single currency this week — following the announcement of the bloc’s recovery fund. But the latest moves suggest the central bank’s attempts to defend the currency may be starting to fail. Official figures on its interventions are not available, but London-based analysts and traders suggest the bank spent about $1bn a day to defend the currency in recent days, taking a heavy toll on Turkey’s foreign currency reserves.

This risky strategy might have worked if coronavirus had gone away quickly and the flow of foreign money that tourists bring to the country’s resorts had resumed. That prospect now seems distant. European countries are reintroducing quarantine policies and warning that a second wave of infections is approaching.

Demand for the cars and white goods that Turkey exports also does not look set to return anytime soon. A collapse in energy prices provided some relief — Turkey’s imports of natural gas feature heavily in its current account deficit — but ironically the country’s relatively effective handling of coronavirus means that domestic demand has not fallen as much as elsewhere. 

The biggest problem, however, is a credit boom that began before the pandemic. President Erdogan has long rallied against an “interest rate lobby” that he believes want higher interest rates to improve the gain on their speculative bets. Higher interest rates, he argues, would damage growth. 

Much of the country’s growth does rely on debt-financed construction and consumption. But that unsustainable path is, if anything, a reason to change course. Cheap money may have helped keep him in power, but it has also fuelled cycles of boom and bust that have dented the rising prosperity that he helped to deliver in years past.

Admitting defeat and accepting a weaker lira might be embarrassing for Mr Erdogan, but it would be a better option than persisting in the delusion that he can resist economic gravity. For his sake, and, more importantly, for the sake of the country, a more orthodox approach is needed.

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