What is the reason for the huge fall in the Turkish lira recently?

Despite its recovery this Thursday, the Turkish lira recorded a historical decline to levels This week’s record low was sparked by President Recep Tayyip Erdogan’s defense of interest rate cuts.

Thursday, the lira was trading at 11.85 by 4:00 GMT, as it strengthened about 1.9 percent from about 12.0820 on Wednesday. And recorded the lowest level against the dollar on Tuesday at 13.45.

The Turkish currency recorded its lowest levels ever against the dollar in 11 consecutive sessions before Wednesday, bringing its losses since the beginning of the year to 45 percent of its value, and incurring about half of those losses since the beginning of last week, which made observers fear its continued collapse.

What is the secret of the collapse of the Turkish lira?

Turkish President Recep Tayyip Erdogan is leading a new monetary policy by defending low interest rates, despite rampant inflation and market hostility, which has precipitated the lira’s collapse. Turkish Tuesday again reached a historic low, as the currency lost more than 43 percent of its value against the dollar since the beginning of the year.

How is this collapse explained?

Contrary to traditional economic theories, President Turki that high interest rates boost inflation. In line with Erdogan’s desire, the Turkish Central Bank, officially “independent”, cut the key interest rate again last week from 16 to 15 percent, below the inflation level of close to 20 percent per year, and this was the third time in less than two months.

Since July 2019, Erdogan has fired three central bank governors and since November 2020, he has replaced the finance minister twice, decisions that each time caused the lira to fall.

The Turkish president denies all responsibility for the collapse of the lira. As Turks struggle to make ends meet, he “rejects policies that will condemn our people to unemployment, hunger and poverty,” he said Monday to justify his policy of growth at any cost.

What are the consequences?

Observers believe that the Turkish banking sector is more robust since the economic crisis of 2001, however they stress that the situation of the banks is a cause for concern. Jason Tovey, an analyst at Capital Economics who specializes in emerging markets says, “The risk is that the lira suffers further sharp declines and causes problems in the banking sector. A credit crunch may occur and this will have a significant impact on economic activity.”

“The main threat also lies in foreign currency deposits. The sign of increased withdrawal requests may lead to a drift toward more aggressive forms of capital controls,” Tovey adds.

Most of the deposits in Turkish banks are made in foreign currencies and most of them are in dollars. Moreover, given that Turkey is highly dependent on imports of energy and raw materials in particular, the depreciation of the lira leads to increased inflation. The official annual inflation rate was 19.89 percent in October, four times higher than the government’s initial target.

In addition, eighteen months before the next presidential term, the permanent deterioration of the economy could damage the “weak” popularity of Erdogan, who has based his electoral successes in the past two decades on his promises of prosperity.

What is Erdogan’s strategy?

The Turkish president appears to be betting on growth at any cost. The Turkish economy is expected to grow by 9 percent in 2021, and 3.5 percent in 2022. He is allaying fears of a currency crisis, saying the government is “encouraging investment, production and exports.”

If the central bank raised its key rate significantly during the 2018 monetary crisis, that possibility seems unlikely today. Erdogan appears more determined than ever to keep interest rates low. Some experts believe that the president thus seeks to enhance Turkey’s attractiveness and encourage foreign companies to invest and produce in the country due to the low cost of labor.

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