Erdogan’s Plan Backfires With ‘Desperation’ in Turkish Lira

(Bloomberg) -- With political discontent growing in Turkey and scattered protests breaking out, President Recep Tayyip Erdogan's disregard for the value of the lira may have reached a breaking point. 

The central bank's move to spend about $1 billion to halt a precipitous decline in the currency shows that policymakers are increasingly worried about Erdogan's plan for economic transformation. It's the first official sign within Turkey that central bankers are willing to take action, even as the president demands lower rates. 

Now investors are openly wondering how much monetary authorities can do to ward off a deeper crisis. Judging by the lira's muted response to Wednesday's intervention, investor confidence remains bleak. 

It looks like a “sign of desperation,” said Mike Harris, the founder of London-based consultancy Cribstone Strategic Macro. Turkey's currency defense is like “spending to build a higher wall, while leaving the gate wide open.”

Erdogan's Lira Experiment Tests His Grip on Turkey

The lira was 1% stronger against the dollar as of 7:36 p.m. in Istanbul, near an all-time low, having retraced a more than 8% surge earlier. The currency has already lost about half of its value this year. 

In the eyes of Erdogan, the lira's weakness is the cost of turning Turkey into an industrial powerhouse and freeing the country from a dependence on short-term foreign cash, which flows into the economy when rates are high. But problems are starting to build that could undermine his grand vision. 

For one, the lira's collapse has battered Turkey's middle class, frustrated investors and fueled discontent with the country's leadership. Analysts say it'll be near impossible for Erdogan to fix the economy before elections in 2023. Even if the weaker lira could help Turkish manufacturers to produce more sophisticated goods, one of the president's often touted goals, it's hard to see it happening in less than two years, they say. 

“If a cheaper lira were a boon for exports, I'd think exports would have been booming for years now,” said Nick Stadtmiller, director of emerging markets at Medley Global Advisors. 

Lira Respite Will Come Down to How Far the Central Bank Can Go

Demanding lower borrowing costs is hardly new for the Turkish president, whose proposition that cheaper money slows inflation defies mainstream economics. 

Driving credit-fueled growth before elections has worked for him in the past and it might also provide another boost this time around. But eventually inflation catches up, and rising manufacturing costs squeeze incomes. 

“The economy needs moderate and stable inflation, and both micro- and macroeconomic reforms that usually take a decade or two,” said Per Hammarlund, chief emerging-market strategist at Skandinavska Enskilda Banken.

For the central bank, how much it can stabilize the lira depends on how much it's willing to spend. The monetary authority says all of the country's $129 billion in gross reserves are at its disposal. However, when swaps and other liabilities are stripped out, the net total is less than zero. 

In the last currency crisis that spanned two years from 2018, Turkey spent $165 billion trying to stabilize the lira and Erdogan's opponents seized on the issue to criticize the government of mismanagement.    

“In the event that the envisioned economic turnaround doesn't materialize, a scenario of rocketing inflation leading to a material slowdown in economic activity or, indeed, to a recession becomes much more likely,” said Phoenix Kalen, a strategist at Societe Generale.

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