Turkish President Recep Tayyip Erdogan’s officials may have successfully mounted an operation to reverse an election week rout in the Turkish lira (TRY) but they seem to have accidentally bought themselves a stock market collapse and a whole bundle of other trouble in the process.

By around 16:20 Istanbul time on March 27 the BIST-100, which tracks Turkey’s 100 largest companies, had shed 5,544 points, taking the index down 5.7% to 91,833—that represented the Istanbul stock exchange’s biggest one-day fall since the days after the attempted coup in mid-2016.

Meanwhile, Turkey’s dollar-denominated sovereign bonds tumbled on March 27 and the cost of insuring exposure to its debt soared to a 6-1/2 month high. Many dollar bond issues plumbed multi-month lows with the 2030 bond falling 2.9 cents in the dollar to trade at 126.75 cents—the lowest level since October 2018, according to data from Tradeweb cited by Reuters. Turkey’s 5-year credit default swaps (CDS) soared to 441 basis points, up 25 bp from March 26’s close, having now jumped by more than 100 bps over the past week, data from IHS Markit showed.

Evaporation of liquidity
Investors were liquidating stocks to get their hands on lira, after Erdogan administration officials essentially brought in moves to arrest a steep decline in the currency by shutting down short-term liquidity. The evaporation of that liquidity made it impossible for most traders to short the lira (borrow it, sell it, then buy it back cheaper) because the offshore overnight swap rate rose to scarcely believable heights—by 16:45 local time, Reuters was reporting that it stood at 1,200%.

Erdogan’s problem is essentially a ‘have cake and eat it’ dilemma. On the one hand his administration persists with an unbalanced economy that is dangerously reliant on short-term flows of hot capital, while on the other—especially in weeks like this one with elections at the end of it—he insists on portraying a populist-nationalist image of being the master of all he surveys, and that means demonstratively refusing to play by the rules of global financial markets, and now even threatening bankers, in order to pick up votes. The president and his officials may well pretty much fall in line after the March 31 elections are over and done with, provided of course that the destabilisation they have wrought on Turkey’s markets this week does not get entirely out of hand.

The drama on London’s swaps market was encapsulated by one comment from a London-based analyst, anonymously quoted by the Financial Times on March 27 as saying that Turkish banks were telling him they had been ordered “not to lend even a single lira to foreign counterparties”.

The offshore overnight swap rate has soared to levels not even seen during 2001, when Turkey endured a financial crisis two years before Erdogan rose to power.

Some foreign banks were unable to meet their obligations at the close of trading on March 26, forcing the Turkish central bank to extend hours for transferring funds in Turkey to 9pm, according to one senior Turkish official, who spoke on condition of anonymity to Bloomberg.

“Astounding self-harm”
After the overnight swap rate rose past 1,000%, Ranko Berich of Monex Europe tweeted: “Absolutely astounding stuff. Nuking short term liquidity makes it impossible to short lira, but gives precisely no reason to buy it. Makes the root problem which is political risk and monetary credibility much worse. Astounding self harm.”

Traders were pointing out that while some speculative traders undoubtedly lost money in the borrowing squeeze, the lira was still weakening. Long-term, capital flight from Turkey would continue and the currency would continue to devalue, they added. By around 18:30 local time on March 27, the lira was 0.06% weaker against the dollar, standing at 5.38, having recovered from 5.45 around lunchtime. Capital Economics said there appeared to have been heavy intervention, probably by state banks, to prevent any serious depreciation taking hold.

Brad Bechtel of investment bank Jefferies reflected on events, saying: “The US dollar/Turkish lira spot rate had kicked off at the end of the week last week on the back of Erdogan’s thrust back into the limelight as he campaigns for local elections. Anytime he gets back on the mic the currency tends to kick off and we’ve had a 7% round trip the last 3 days in spot.

“Expect the currency to remain volatile throughout this election cycle as the market will take the sentiment in the local elections to be a vote of confidence on Erdogan himself. Also the longer he keeps talking the more we are likely to see these extreme moves.”

At around 18:00 local time, Reuters reported the head of Turkey’s banking association as denying that domestic banks were deliberately withholding lira from foreign rivals.

In a statement to the news agency, Huseyin Aydin said the reason behind the rise in lira swap rates was that there was not enough lira for foreign banks to buy dollars. He added that Turkey had shown the necessary stance against a speculative attack on the lira. Turkish banks were not sources of liquidity, he said, but rather they were looking for themselves. He said decisions by banks on liquidity were business-based and in line with international laws and regulation.