Turkey’s Don Quixotesque President Recep Tayyip Erdogan spent much of March 28 mounting his exhausted horse for the latest round of the currency battle he has declared against international speculators shorting the embattled Turkish lira (TRY). It was quite some chapter.

There were conflicting accounts of how they did it but investors in London—left terribly thirsty for lira since the Erdogan administration conspired to suck up nearly all the short-term offshore liquidity of the currency at the beginning of the week—somehow accessed fresh supplies of lira forcing the TRY back on to the back foot. The Turkish central bank, meanwhile, again hiked local lenders’ swap limits in a move observers took as the latest sign of the bleeding of reserves.

The media were again waiting on Erdogan’s next word and they weren’t disappointed. The executive president asserted that he is an economist and also sharpened up his rhetoric against the US—although in criticising its Golan Heights support for Israeli PM Benjamin Netanyahu, he did not utter the word “Trump”, a noteworthy omission as analysts assess how much angry pre-March 31 local elections bravado Turkey’s populist leader can get away with without sending markets into an even more dizzying tailspin, squandering votes in the process.

TRY sags to 5.55
By just before 23:00 Istanbul time on March 28 the TRY stood at 5.55 to the USD, 2.64% weaker on the day, but such was the volatility in trading that the previous 24 hours saw the currency fluctuating between a range from the 5.32s to the 5.62s. The Istanbul stock exchange’s benchmark BIST-100 index, meanwhile, also found itself on a rollercoaster ride, moving between 91,000-93,800.

Turkey’s 10-year benchmark domestic bond yield climbed as high as 19.12% at the March 28 market opening before recovering to 18.66% as of 18:00 local time, though that was still 485 bp higher than the lowest level seen this year. The 2-year benchmark yield saw as high as 21.21%, 323bp higher than this year’s lowest level.

Fresh hopes that lira liquidity was on the rise also helped Turkey’s dollar bonds recover some ground in another zig-zagging episode, according to Reuters.

But, the news agency also reported, Turkey’s 5-year credit default swaps (CDS) reached 506, up 177bp over the past week, as the Erdogan effect produced market jitters that quite logically drove up the cost of insuring Turkish debt.

As liquidity came into the picture, the London overnight swap rate fell to as low as the 35%s on March 28 following the scarcely believable 1,200%s recorded on the previous day after the markets realised Erdogan’s decision to go into hand to hand combat with ‘the shorts’ was for real. It was a clear sign that the London brigade had accessed the lira.

Cash from stock and bond sales arrives
The news flow on exactly how was confused. Unable previously to get hold of lira through the usual channels, the London-based players started shedding Turkish stocks and bonds instead and the cash from such sales would have started arriving on March 28. But earlier on in the day, an unnamed senior official told Reuters that Turkish banks had started providing lira to the London swaps market.

That statement proved the latest sign of the disharmony in Turkish economic management, as the official thus unwittingly confirmed that Turkish banks had been deliberately cutting the offshore liquidity. Subsequently, two unnamed senior bankers later told Reuters that Turkish banks had fulfilled their obligations on the London swap market in recent days and that it was not true that the day had seen them restarting liquidity as they had never stopped.

The day also brought conflicting news on the Turkish central bank’ reserves. Firstly, the national lender’s regular weekly bulletin suggested that the net international reserves fell to TRY142.2bn ($24.7bn) as of March 22. That pointed to a decrease of around $10bn across the first three weeks of the month, according to Bloomberg’s calculations.

Next, the governor of the central bank, Murat Cetinkaya, arrived the stage to state that the authority’s gross FX reserves actually grew by $4.3bn to $96.7bn as of March 27. Net reserves also rose, by $2.4bn across last week to $28.6bn, according to Cetinkaya.

“No room for error”
“There are very few other countries whose level of FX reserves is as low as Turkey’s. With reserves down to this level, they really have no room for error and there is a lack of confidence, and that needs to be addressed,” Paul McNamara of GAM Investments told Reuters.

“It is a signal that the central bank is supplying part of the economy with FX reserves and not through the market. That indicates that the exchange rate is an issue, and also that the central bank is meddling in economic policy, which isn’t really what it should be doing,” the news agency cited Ulrich Leuchtman of Commerzbank as saying.

Turkey’s import cover ratio—the  number of months that imports can be sustained should all foreign exchange inflows seize up—stands at around four months, compared with more than six months for South Africa and 18 months for Russia, latest IMF data shows.

During the early morning hours of March 28, a central bank swap move was taken as another sign of haemorrhaging reserves. Turkey’s central bank raised its total lira swap sale limit to 30% from 20% for swap transactions that had not matured in a move aimed at increasing its forex reserves, unnamed bankers told Reuters. Previously, on March 25, the regulator raised the limit to 20% from 10%.

As the central bank is also limiting its lira funding to local lenders, having scrapped one-week repo auctions on March 22, it is basically pushing Turkish banks to access the local currency by switching their FX for lira in swap transactions. The move was expected to have added $2.5bn to its reserves, somne analysts said.

The central bank’s weekly bulletin also revealed that total forex deposits and funds, including precious metals, of Turkish local individuals and institutions had grown further, moving up by $3.5bn w/w to an all-time high of $179.3bn as of March 22. Some market observers said that locals’ FX purchases since the beginning of this week could have amounted to $3bn.

“People are panicking”
Mustafa Alkan, a manager at a foreign exchange office in Istanbul, told Reuters that demand for hard currency had been high over the past three weeks. “People are panicking—when the dollar increases, they panic and buy… There is a view that the dollar will go back to the levels it saw [last summer during the lira crisis],” he said, adding that some customers had arrived at his counter with tens of thousands of lira stuffed in their pockets.

Local individuals’ FX deposits hit a fresh record of $105.7bn as of March 22, according to the latest available official data.

Getting back to Erdogan on the campaign trail—fully conscious that the local elections have become a referendum on his long stint at the helm, especially as some critics say he’s taken Turkey up poop creek without a paddle, the president has been giving speeches at half a dozen rallies per day all week long—and we find the strongman addressing a bunch of youngsters.

“I am an economist,” he tells them, while reiterating some of his revolutionary ideas on the relationship between inflation and interest rates and, breaking new ground, making an incomprehensible reference to differences between the perspectives of Keynes and Adam Smith.

“Keynes and Adam Smith have turned in their graves”
"Today, Keynes and Adam Smith have turned in their graves," co-head of the opposition Peoples’ Democratic Party (HDP), Sezai Temelli—a former public finances professor at Istanbul University who was dismissed from his post via a presidential decree in 2016 following the failed July coup attempt—said in his reaction to Erdogan’s quick economics lesson.

Durmus Yilmaz, a former central bank governor and deputy head of another opposition party, the Iyi (“Good”) Party, is known for suffering no nonsense when it comes to Erdogan's views on economy theory. In reply to a question during a radio programme, Yilmaz said that discussing the president’s comments on such matters was a waste of time, adding that the economic resources spent on debating his views in the sphere should be subtracted from the GDP figures.

Nobody, of course, is about to suggest that face to face to the boss. As Erdogan asserted once more during his day of brisk campaigning, it is he who is “in charge of Turkey’s economy” and, mark his words, interest rates are the country’s main issue and—shake your head as much as you like—inflation would begin to fall in earnest if they were cut.

Warming to one of his regular international conspiracy themes, Erdogan also declared that Turkey had thwarted “attacks” by the US and the West on the lira while some unspecified banks were playing games with the currency ahead of the Sunday elections. Turkey, he said, must “discipline speculators in the market”, he added, according to Reuters’ translation.

“They can’t find lira now, they are struggling in terms of payments. The tables have turned. While they can’t do [these payments], the lira firms and the dollar falls,” Erdogan added in his potted economics lecture for his young supporters.

Further along the campaign trail, Erdogan and Turkey’s finance minister, the president’s son-in-law Berat Albayrak, were saying some things the market actually wants to hear (though whether Turkey’s economic policymaking credibility is shot by now is a fair question). Structural reforms, they said, would be on the way once polling day was done and dusted.

Waiting for the dust to settle
“When the dust settles, whether portfolio managers want to continue to invest in Turkey or not… We will have to wait and see,” Ugras Ulku of the Institute of International Finance (IIF) told Reuters.

“The turmoil in Turkey’s financial markets has raised external borrowing costs, making it more difficult to roll over the country’s large external debt burden. The risks are largest in the banking sector,” William Jackson of Capital Economics said on March 28 in a research note entitled “Turkey’s banks the weakest link during market stress”. He added: “Turkey’s large current account deficit—a perennial point of concern for investors—has undergone a very large adjustment since the lira crisis last year. But the country’s balance sheets are still weak. The external debt burden remains very large and foreign exchange reserve coverage is low.”

Jackson also wrote in his note: “Indeed, the ratio of short-term external debt (i.e. that maturing within 12 months) to the central bank’s gross foreign exchange reserves is larger in Turkey than in any other major EM. And that’s based on the central bank’s gross FX reserves. The central bank also has large FX liabilities—a result of the reserve option mechanism, in which banks can hold foreign currency as required reserves against lira denominated liabilities (see here).

“The central bank’s net FX reserves are much lower. The external debt burden is concentrated in the banking sector—about two-thirds of total short-term external debt is owed by banks. This is a result of the credit boom of the past decade, in which banks funded domestic lira lending by borrowing in foreign currencies from abroad.

“Banks face hefty debt repayments in the coming months. So far, the yields on banks’ dollar bonds have risen by about 200bp since last week. That’s not as severe as during the lira crisis last August. But it may prove prohibitively expensive for some banks to roll over their debts. Alternatively, banks could sell FX or lira assets.

“Banks do hold large amounts of liquid FX assets at the central bank under the reserve option mechanism (the counterpart to the central bank’s FX liabilities). However, these stand at just $30bn—equal to just a third of banks’ short-term external debt. Meanwhile, selling lira assets would put the currency under further pressure. And either way, banks would be shrinking their balance sheets which would cause credit conditions to tighten.”

Robin Brooks, chief economist at the Institute of International Finance (IFF), writing on Twitter, reminded observers that “Turkey last summer suffered a ‘sudden stop’ in the balance of payments, which shifted the current account from deficit into balance at unprecedented speed. Recent stress on the Lira—basically another sudden stop—will take the current account into surplus, a plus for the Lira.”

He added: “Turkey's election uncertainty factors into recent stress on the Lira, but the real issue is growth. Strong credit-driven growth in 2017 was too much for foreign markets to finance, bringing about a BoP sudden stop. The Q1 credit impulse is a repeat with another sudden stop now.”