Taking a look at TRYUSD, we can see that the Turkish Lira has had an eventful couple of years. Amid heightened tension and uncertainty due to Covid-19, what’s happening in Turkey right now has been somewhat muted. From unconventional views on monetary policy driving 1000% spikes in offshore markets, to liquidity issues arising from state-owned bank actions, the Turkish economy is in a dire state and I’m going to run through the events leading up to this point, with focus on the authoritarian and unconventional economic policies implemented by President Recep Tayyip Erdoğan. We have a lot to get through and as a result this will be presented in two parts.
At the time of initial turbulence, FinFoc’s Saqlain Choudhary wrote the following piece ‘What goes up must come down: the Turkish Lira’ , a great read, though not a pre-requisite of this article: rest assured I will run through the main points.
In 2018 the Turkish Lira suffered prolonged depreciation against the dollar, seemingly tearing apart the decade long momentum built up to that point. Turkey had previously been subject to exponential growth and improvement as infrastructure provided a pinnacle for the future. However, at this point in time, the last 12 months saw the Turkish Lira as the worst performing currency. With the government running a current account deficit*, inflation running at 15.9% and high levels of debt in the private sector, this steady decline followed by sudden and unprecedented drops in the currency’s value is not the fallout of one event but a stream of unfortunate decisions.
*The current account deficit is a measurement of a country’s trade where the value of the goods and services it imports exceeds the value of the products it exports. 
From a far, Istanbul’s skyline mimicked that of New York or Dubai, whilst up-close revealed the half built, unoccupied reality. The problem was that the government was piling money into infrastructure when the foundations of such investments were not sustainable. For example, the current account deficit model being ran places too much reliance on foreign imports. The raw materials required to develop the investments stretched government expenditure to 20% of Turkish GDP for the last 5 years on this alone. This alongside 90% of construction capital requirements being financed by foreign loans created huge exposure to the depreciation of the Lira. Then a lack of foreign interest in these projects essentially buried them before they were complete, leaving the infrastructure prospects as depreciating assets, with ever increasing costs, stalling demand and poor execution. And whilst the rest of the world began to realise what was going on, confidence alongside value of the Lira decreased and those 90% of foreign loan repayments mentioned earlier become more expensive.
The immediate crash was a result of the points above, with a push from a couple of external factors. Firstly, at the time President Trump announced trade tariffs on Turkish steel and aluminium were to be doubled, as a retaliation towards charges on an American Pastor in light of espionage and terrorism claims. In turn, investor sentiment towards the Lira depreciated. With the balance sheet ever growing for the Turkish government amid the abundance of foreign loan repayments due, cutting its main revenue stream to foreign currency reserves essentially pulled the plug on the Turkish economy.
And finally, the last factor in this decline, which will prove to be a prominent theme as we continue along the timeline to today, is the unconventional monetary policy and central bank operations driven by the Turkish leader Tayeb Erdoğan. The Turkish central bank doesn’t act independently and is state controlled, aiding Erdoğan’s control and fuels his unconventional policies. In a time where the government needed foreign investment, the central bank’s restrictions on foreign currency liquidity made it hard to hedge exposure to the ever-weakening Lira. Thus, while it does stop the number of short sellers involved in the economy, it proved to be disastrous as investors continued to lose interest. Erdoğan is also a firm believer in not hiking interest rates to reduce inflation, which did absolutely nothing to improve the crippling 15.9% at the time. He prefers to lower borrowing costs to reduce fuel cost and continue expansion. However, what he may fail to realise is that the more uncontrollably the economy grows the more violently it will collapse.
In late August, Turkey’s currency crisis looked to be going nowhere amid the overhanging threat of the US further increasing tariffs on imports and Erdoğan’s control other monetary policy. However early September presented respite for the Turkish economy as at the same time as the BoE and ECB, the Turkish central bank met to discuss interest rates. Erdoğan publicly announced, “tough times call for tough measures” and said: “We should cut this high interest rate.” The bank had been expected to lift interest rates, however President Erdoğan described high interest rates as a “tool of exploitation”. Fortunately, Turkey’s central bank defied calls from Erdoğan and voted to raise interest rates from 17.75% to 24%. This fuelled an immediate jump for the Lira against the Dollar. However, Erdoğan was not pleased: “Yesterday the central bank issued the constantly debated interest hike, and at a very high rate. They talk about the independence. There you go, independence. We will see the outcome of the independence.”  Though Turkish economic growth dwindled to 1.6% year-on-year in the third quarter of 2018, falling short of estimates of 2%, due to its currency crisis and soaring inflation, it seems the ‘independence’ served the country well as through to 2019, the Lira continued its slow climb against the dollar.
It seemed as though Turkey wanted to prevent the Lira’s 34% loss of its value against the dollar of the previous summer at all costs. Ahead of March local elections, the Turkish government came up with an innovative way to prevent its currency from falling – make it impossible for foreign investors to sell the lira. According to bankers afforded anonymity, that spoke with Bloomberg, Turkish banks were under pressure to not provide liquidity, meaning many foreign hedge funds were trapped in Lira trades. These unconventional measures succeeded in strengthening the currency, pushing the lira as high as 5.3 to the US Dollar. Though as the authorities unwound their bid to prevent short selling, the London overnight swap rate spiked to over 1200%, as lira liquidity was withheld from the London market, before moving back to normal levels of around 35% the next day. The official explanation: a response to a ‘speculative attack’. The Turkish lira then plunged as much as 5% against the dollar as a return of liquidity entered foreign markets, and market conditions began to normalise. This type of government interference on economic policy is far from conventional and captures exactly how committed Erdoğan is to implement control.
With the lira sliding 2% just two days before the important elections, Erdoğan was fighting to retain control of some of Turkey’s biggest cities. His ruling party had given a backdrop of high inflation and rising unemployment triggered by last year’s currency crisis. Eager to avoid adding the plunging lira to the list of voter gripes, he rallied against “speculators” and blamed the country’s economic woes on an attack by external alliances.  What followed was a terrible result for Erdogan and his party. With one of the worst performing elections in his 16-year tenure to date, the capital Ankara was lost alongside a narrow loss in Istanbul. This left Erdogan in a very vulnerable position amid the economic crisis very much still present within the economy, an international standoff with the US and now a shock electoral defeat that damages foreign investor sentiment.
The lira dropped sharply as the market priced in on Erdoğan’s electoral defeat, falling a further 2.5% to the dollar early the following day. Whilst Erdoğan scrambled to reassure investors after the shock defeat. Turkey’s problems became increasingly difficult to assess, although government debt was still low by emerging markets standards, no one knew the extent of off-balance-sheet liabilities — in particular, guarantees given to the grand infrastructure projects mentioned earlier. However, Erdoğan’s disregard for conventional economics and his appetite for geopolitical confrontation remained a big risk. Seemingly, the election along with its result wasn’t enough for Erdoğan, as government pushed for a re-election in Istanbul which drove the lira even further down to a 7-month low. In an attempt to try and take advantage of the narrowness of the loss, Istanbul’s mayoral election was to be held again in June, with the government claiming fraudulent activity had put the legitimacy of the result into question.
Between Erdoğan’s defeat and the re-election, despite the recent trauma, the US agreed to cut tariffs on Turkish steel from half to 25%. It did, however, only provide a brief respite for the lira. In this time, the central bank held rates steady ahead of the re-election, despite calls from Erdoğan for a ‘definitive solution’ amid sky high inflation. The re-election came as a huge blow for Erdoğan, as his party’s opposition secured a resounding victory, in-turn, strengthening the lira. The second defeat brought a much larger majority as Erdoğan reflected on what for years, he had warned his party faithful: losing the city means losing Turkey. We’ll discover how true this warning was in part two.
2nd year mathematics student at UCL