Why is Turkey’s currency in freefall?

Why is Turkey’s currency in freefall?

AFP

ANKARA: The Turkish lira has been in freefall as President Recep Tayyip Erdogan has championed interest rate cuts despite rampant inflation.
The currency hit a record low this week -- exceeding 13 to the dollar -- and has lost over 43 percent in value against the US greenback since the start of the year. Here are key questions about the lira’s collapse:
Why is the lira crashing?
Erdogan insisted this summer interest rates had to fall, taking the unorthodox view that high rates equal high inflation.
The central bank has since slashed the main interest rate by 400 basis points, sparking doubts about its independence. In its latest decision last week it suggested another cut was likely in December. But the lira’s issues go deeper.
Erdogan, who has sacked three central bank governors since July 2019, has refused to accept any responsibility for the lira’s collapse.
“I reject policies that will condemn our people to unemployment, hunger and poverty,” he said on Monday, warning that the country was in a “war of economic independence”. Kerim Rota, who is in charge of economic policy at the opposition Future Party, said the lira was suffering the worst monthly devaluation since 1994, and the second worst in the past 40 years.
“If it reaches 14.25 (to the dollar) at the end of the month, it will be the highest. It’s now out of control, this is clear to see,” Rota told Halk TV in an interview Tuesday. The Turkish currency rose on Wednesday, trading at under 12 lira to the dollar.
What are the risks?
While many say Turkey’s banking sector is stronger since the 2001 economic crisis, there are concerns about the impact on banks and the potential for capital controls.
“Banks are better placed to cope with the spillovers from a weaker lira than they were a few years ago,” said Jason Tuvey, an emerging markets analyst at Capital Economics.
But, he added, “the risk is that the lira suffers further sharp and disorderly falls that do trigger problems in the banking sector. A credit crunch could ensue that weighs heavily on economic activity.”
Any signs of a “flood of withrawal requests” from foreign exchange deposits would likely trigger more aggressive capital controls, he warned. Over half of all deposits in Turkish banks are in foreign currencies, mainly dollars.
Turkey’s official inflation target is five percent but has stubbornly remained in the double digits in the past two years, nearing 20 percent last month. Opposition parties say real inflation is much higher than what the official data shows.
Given the situation, the opposition has called for an early election ahead of a scheduled vote in June 2023, but Erdogan vowed Tuesday that “there will be no early election”.
What does Erdogan expect?
The president is prioritising growth with the economy expected to expand by nine percent in 2021 and 3.5 percent in 2022.
During another currency crisis in 2018, the central bank aggressively hiked the main interest rate but the likelihood of a repeat under a more determined Erdogan is low.
Some experts have accused the president of seeking to make Turkey more attractive as a hub for cheap production with Turkish wages worth less in dollar terms. Turkey’s net monthly minimum wage of 2,825.90 liras amounted to $380 in January 2021 but as of Wednesday was equivalent to $222.
“Until recently, Team Erdogan’s ‘2023 goals’ included becoming a post-industrial powerhouse and a high-tech leader. Now, it’s to make Turkey a source of ultra-cheap labor,” tweeted Duke University professor Timur Kuran.