‘Uncharted’ fluctuations returned to the Turkish markets on March 22 for the first time in six months. It made for a tough day for investors who suddenly found themselves amid menacing seas.

The Turkish lira (TRY) was back in the wars. It lost 5.42% d/d against the USD to close the week at 5.76 after weakening as far as 5.85. The Borsa Istanbul’s benchmark BIST-100 saw a drop of 3.45% d/d, taking it to 99,835, a descent that pushed the index below the psychologically important 100,000 threshold for the first time since January. The banking index fared worse, losing 6.64% d/d.

Turkey’s dollar bonds also fell across the curve. The 2043 issue tumbled to its lowest since mid-January, Reuters reported. The country’s 5-year credit default swaps (CDS), meanwhile, were recorded at 381 by the end of trading on March 22, against the previous day’s 351.

Day began badly
The day had begun badly with a global sell-off in emerging markets assets. But Turkey’s market rout was triggered by Turkish President Recep Tayyip Erdogan’s response to US President Donald Trump’s tweet suggesting Israeli sovereignty over the Syrian Golan Heights should be recognised.

By Erdogan’s standards, his reaction to Trump’s latest foreign-policy-bombshell-by-tweet was actually pretty mild. In a speech at a gathering of the Organisation of Islamic Cooperation (OIC), he reportedly said: “We cannot allow the legitimisation of the occupation of the Golan Heights.” 

He was also cited as saying that Trump’s statement brought the region to the brink of a new crisis, but Turkish public broadcaster TRT World released a video of Erdogan making his Golan comments and they do not really amount to much more than a few reticent sentences in passing; the remarks have nothing on the yelled angry rhetoric we are used to from Erdogan, such as what he is presently dishing up at rallies on the stump for the upcoming March 31 Turkish local elections.

It is actually hard to rationalise Erdogan’s interest in the Golan Heights. The territory is internationally recognised as not Israeli—but that means the region in the Levant, under Israeli occupation since 1967, is in fact seen as that of Erdogan’s arch-enemy Syrian President Bashar al-Assad. There is of course the angle that Erdogan is seizing on the issue to step up his confrontation with Israel and opposition to Trump’s full-on backing of Israeli PM Benjamin Netanyahu, another bitter enemy of the Turkish strongman, against the Palestinians. But at the end of the day there will be plenty of Turks not particularly interested even in where the Golan Heights are located—they have nothing to do with Palestine, they are “Alevi” Assad’s territory. Or is Erdogan getting ready to strike a deal with Assad as urged by Vladimir Putin in January?

Unnecessary organisation
The OIC is an unnecessary organisation. But it is presently led by Erdogan and he calls OIC gatherings whenever he wants to send a message to his voters. Erdogan’s media machine swings into action, portraying his superfluous words at the OIC as important pronouncements coming from the purported leader of the Islamic World. Erdogan made plenty of noise at the OIC when Trump last year announced the US would switch its embassy in Israel to Jerusalem, but the issue was then quickly forgotten.

Notably, Erdogan was the only president who attended the latest OIC meeting, held in Istanbul. Iran was represented by its foreign minister Javad Zarif, while Saudi Arabia sent its ambassador to Ankara, Reuters reported. New Zealand’s foreign minister Winston Peters was also there for a quick tête-à-tête with Turkey’s populist leader following his decision to use footage of the Christchurch terrorist mass shootings at his election rallies and make incendiary comments such as “This is not an isolated event, it’s something more organised” before later accusing the west of “preparing” the killer’s manifesto and “handing it to him”.

A regular Erdogan voter who watches the rallies—literally aired all-day-long on Turkish television—might easily think by now that New Zealanders are boarding ships to attack Turkey via the Dardanelles, just as the Anzacs aboard British Royal Navy ships did during World War I.

Peters, who prior to departing for Turkey made it plain he thought Erdogan’s comments might place the lives of New Zealanders in Turkey at risk, met Erdogan and then told reporters he did not ask him to stop showing the footage, filmed by the alleged killer, of the mosque shootings because he understood the screenings had stopped, according to Reuters.

However, two hours later Erdogan again showed excerpts from the video at a rally, the news agency reported.

Made a ‘darling’ by the west
Erdogan, let’s not forget, was made a ‘darling’ by western capitals led by Washington. One day, the whole planet might like to stop to think for two seconds how the other half of the Turks—those who look upon his works and despair—have felt since he took the helm of the country back in 2002.

After Erdogan’s Golan remarks ignited a small earthquake under the already fragile Turkish markets, the central bank stepped in with a return to unorthodoxy. As the lira nosedived, it announced in a written statement that one-week repo auctions would be suspended for a certain period of time. 

Liam Carson of Capital Economics subsequently released a research note observing: “The continued plunge in the Turkish lira today, even after the central bank (CBRT) took steps to tighten monetary conditions, highlights the bind the institution is in… The most likely explanation for this is that markets see the move as a reflection of the limitations of the central bank. It is still resorting to backdoor tightening (via the use of its interest rate ‘corridor’) rather than raising official interest rates.

“It has used the ‘corridor’ in the past to tighten monetary conditions while avoiding a vitriolic response from President Erdogan. Mr. Erdogan has said surprisingly little about monetary policy recently. But for all of the central bank’s hawkish rhetoric since September’s aggressive rate hike, today’s move is a reminder that politics will continue to cast a shadow over its policymaking.”

“[H]iking the base rate, the 1-week repo rate. Could be last chance for current CBRT management to prove themselves. They need to show they have learned,” senior emerging markets sovereign strategist Timothy Ash of Bluebay Asset Management reacted in an emailed note to investors. “Today’s move is [just] about buying time.”

Also on March 22, Agriculture Minister Bekir Pakdemirli announced that TRY1.4bn worth of agricultural support payments would be executed at 18:00 local time. That meant there would be an additional chunk of liquidity in the Turkish markets in election week.

Albayrak takes to the airwaves
On the evening of March 22, Erdogan’s telegenic son-in-law and finance minister Berat Albayrak took to the airwaves for a joint live broadcast made by several loyal TV stations. Speculators were talking down the economy on social media and this was similar to what happened during the anti-government Gezi Park protests in 2013, he said. Albayrak did not offer examples or names.

Just lately, Albayrak was making fun of those who bought dollars at 6 lira, saying that it was unwise because everything would be so much better after the elections and the worst of Turkey’s economic turmoil had been over and done with since last September. He even went so far as to claim that inflation, currently a touch below 20%, would be in the single digits six months from now.

To be fair, the Erdogan family’s ability to connect almost everything to Gezi is remarkable. The world’s best conspiracy theorists seem wet behind the ears in the face of their constructs. The Erdogan regime’s prosecutors, on the other hand, are a little lazy with their bills of indictment. Sometimes they just copy-paste. But the stories they tell are almost always in the surrealist genre. They have a certain style.

Shocked by fall in reserves
On March 21, the day before Albayrak went live on TV, some market observers were shocked by a $6.3bn fall in the central bank’s net international reserves in the two weeks to March 15. The reserves were down to $28.5bn according to the regulator’s weekly bulletin, marking the biggest drop since January 2014, when the monetary policy maker was eventually forced into raising rates in an emergency meeting to prop up the lira, Bloomberg noted. The observation was made one day before the central bank scrapped the one-week repo auctions to deliver an implicit rate hike.

“The latest decline in reserves can’t be explained by external debt payments alone, which amount to a total $3.8bn for March, according to the Treasury’s financing program,” Bloomberg also noted.

Some observers cottoned on to how the decline in the FX reserves did not match the rise in lira reserves.

The awaited explanation came from an unnamed central bank official late on the evening of March 22. There was nothing unusual in the fall of the reserves, the official said, as it was due to $5.3bn worth of external debt payments along with FX sales to energy importers, Reuters reported.

The Treasury’s external debt repayments or current FX transfers, as well as its domestic and external FX borrowings, FX sales to energy importing public companies, export rediscount credits, and lenders’ FX-denominated required reserves along with foreign exchange deposits against Turkish lira deposit auctions, FX collateral deposit transactions, FX and lira swaps could result in some “temporary” fluctuations in reserves, according to the unnamed central banker.

Some patriotic economy pundits find it stupid to think that the lira was being manipulated by the central bank because “it is a free market and how could the central bank do that”. Data for the central banks’ foreign exchange deposits against Turkish lira deposit auctions, FX collateral deposit transactions and FX-lira swaps is available on the authority’s official website under the “Markets Data” page. Data on the central bank’s growing short position in FX contracts on the Borsa Istanbul’s derivatives market is available on the BIST’s official web page.

Intriguing IMF comments
Meanwhile, IMF spokesman Gerry Rice’s intriguing comments given at a regular daily press briefing on March 21 in response to a quick question on Turkey, namely that “there are a lot of reports that the cracks in Turkey’s economy keep getting larger”, passed unnoticed amid Erdogan’s noise.

“I don’t have a great deal to tell you on Turkey…, except that we are, IMF staff are, now assessing…, the possible impact of the recently announced tax changes. More broadly speaking, Turkey’s economy is slowing sharply, and underlying vulnerabilities remain. The authorities are urged to pursue a comprehensive set of policies to credibly and consistently address the key underlying imbalances. Again, we’ll have more to say in a couple of weeks,” Rice said, according to the script of his press briefing.

There could be a question here as to whether the IMF staff are discussing a post-election deal for Turkey. Rice’s face might better explain the IMF’s assessment of the Turkish economy, starting from the 28th minute of the video of the briefing.

Raci Kaya, who represents Turkey at the IMF, was quick to respond to Rice’s comments. He told the state-run Anadolu news service that Rice’s statements “can’t be viewed as sincere,” according to Bloomberg’s translation.

“If Rice had asked us for adequate information, we’d have provided that,” Kaya also said, adding that he was puzzled by Rice’s statements. The Turkish economy had signalled a return to growth in Q1 and the IMF should be more careful about its assessment of Turkey’s economy and “communicate with [government officials] better,” according to Kaya.

“It’s puzzling that they are puzzled...,” Ash at BlueBay said in an emailed note to investors.

Unfortunately, it’s time again…
It is unfortunately time again to remind ourselves of last year. In February 2018, the IMF warned that the Turkish central bank’s monetary policy should be tightened to deal with rising inflation and that the current account deficit was growing and the budget metrics were deteriorating. Vulnerabilities included large external financing needs, limited foreign exchange reserves, increased reliance on short-term capital inflows, and high corporate exposure to foreign exchange risk, the Fund pointed out.

“They tell us to slow down growth,” Cemil Ertem, an advisor to Erdogan, said in a response to the IMF’s warnings. “We’re going to do the exact opposite.”

As was the case from April to the beginning of September last year, the long list of reasons behind the lira weakness is in rude circulation again. The list now lacks “the skyrocketing current account deficit”, but it has hardly grown much shorter.

Still creating jitters are elections (local ones this time, though note that the municipal polls due next weekend are the last scheduled elections Turkey must hold for around four years), volatile relations with the US (there’s serious angst over how Ankara and Washington can resolve their stand-off over Nato member Turkey’s plan to acquire Russia’s S-400 advanced missile system while still demanding its order for a juicy S-400 target, namely the west’s most advanced jet fighter, the F-35, be fulfilled, but the brittle Trump-Erdogan accommodation could also be seriously disrupted by more rows over US support for Syrian Kurd militants, Ankara’s failure to abide by the White House’s Iran sanctions and perhaps action from the US against Halkbank in relation to a sanctions-busting case, or perhaps the throwing of another “jailed pastor” into the equation, among other possibilities), the continued expansion of dollarisation among Turks, measures hobbling the free market (such as officials “encouraging” banks to cut deposit and lending rates and boost lending volume, state interference in private trade such as via Albayrak’s street stalls selling discounted vegetables to combat alleged price gouging in shops, raids on warehouses to meet the state’s pricing behaviour objectives, price controls and so forth), conflicting monetary and fiscal policy stances (the policy rate stands tight while the government simultaneously pumps money into the economy via public lenders and booming fiscal expenditures), abnormal (or ‘new normal’) domestic policymaking driving the polarisation of society, sticky official inflation that won’t budge far from 20%, high external financing needs demanding unabating inflows of capital, the ongoing recession failing to transition to a V-shaped recovery but taking the L-shaped course instead, limited FX reserves… The list is legion.

Markets buy the “rebalancing” story
Until last week, Turkey’s “rebalancing” theme was being successfully sold harmoniously by the Turkish government and its hot money financiers in London. The turnaround in perception came not too long after the currency crisis reached its nadir in August. Fresh from being appointed finance minister following Erdogan’s re-election in late June’s snap poll, Albayrak “listened” well during meetings he held in the inner sanctum of global finance (although his plan to bring in ‘blue-blooded’ Wall Street consultants McKinsey was a step too far for Erdogan who tore the commission to shreds).

Officials and foreign commentators became sure the story of Turkey getting back on the rails was working efficaciously. You might say, however, that people were being lulled to sleep, expected to enjoy their slumber despite Turkey’s record-breaking dollarisation and heavy sell-off by non-residents of domestic government debt paper, which began flicking on red lights at the beginning of March.

The sharp contraction in the alarming current account gap is given as representing the proof of the pudding in the so-called “rebalancing” story. Some foreign analysts even expect Turkey to move to a surplus. For sure, it is within grasp, but it would simply mean more Third World rats waiting in cheap-veg queues and more Third World businessmen waiting in debt restructuring or bankruptcy protection queues or the onset of horribly long bankruptcy queues.

Would it be possible for the Erdogan regime to curb public reaction against intensified “rebalancing” with only sticks and dramatically less carrots? It surely would be, but it would obviously require more external support to overlook blatant deficiencies in Turkey’s undemocratic democracy. And the cost to be paid in the form of interest payments could only go up even further.

One of the main themes in the much hawked “rebalancing” tale is the commending of the central bank for last autumn biting the bullet and pushing up its policy rate to 24%, although the disparity between the “encouraged” market rates and official inflation—officially given as just below 20% but there are those economists who say it must stand a good deal higher—has reached uncontainable levels, fuelling FX deposits. Despite the heavy PR campaign suggesting Ankara would adhere to a strong fiscal stance, the wash of pre-election liquidity let loose via public banks’ lending and government expenditures also obviously add to FX demand.

Since the beginning of 2019, pinkish-as-much-as-fragile global sentiment has also supported Turkey’s “rebalancing” story. However, “a spell of relative calm for EM currencies was broken this month, as several including the Argentine peso, Turkish lira, Brazilian real and South African rand fell sharply, despite a more dovish US Fed”, Capital Economics highlighted on March 22 in a note entitled “EM currencies come back into the firing line”.  “[Y]ields on local currency government bonds rose across the [Emerging Europe] region, but the largest rise came in Turkey,” the economic research company said on the same day in its weekly regional chart book.

Eurobond markets start to “tire of Turkey”
More bad news came on the eurobonds front. Turkish lenders were on the market for syndicated renewals that were to be completed by April or May, but as Lewis McLellan of Global Capital commented on March 21 in a piece entitled “Markets beginning to tire of Turkey”: “Turkey’s capital markets rehabilitation has been one of the most remarkable emerging markets stories of the past six months, but investors’ appetite for the nation’s paper is finally starting to wear thin.”

State-controlled lender Vakifbank said on March 21 in a bourse filing that it sold $600mn worth of 5-year USD-denominated eurobonds but at a coupon rate of 8.125%.

Meanwhile the on-off US-China trade war (not to mention rumblings of a showdown ahead between Trump and Europe), Brexit and global slowdown woes are still on the horizon when it comes to the external front.

“But it is fair to say that the writing has been on the wall for the lira for some weeks now, and particularly because of steadily rising dollarization as reflected in the constant accumulation of FX deposits by the population. This underlying lack of confidence by locals for the lira is pretty telling—as they don’t seem to buy the story. And if they don’t then why should foreigners?” Ash, a devoted lira bull from the beginning of September to March, agreed on late March 22 in an emailed note to investors after a trip to Turkey.

On March 22, Robin Brooks of the Institute of International Finance (IIF) and Ash attended a panel at the Uludag Economy Summit held in the northwestern city of Bursa, the heart of Turkey’s automotive industry. Their main call was for the Turks to make a clear return back to the Western fold.

Net sales of domestic government debt securities executed by non-resident fixed income investors amounted to $1.41bn in the 12 week-period from December 21 to March 15, according to the latest data from the central bank. In the same period net purchases of Turkish equities by non-resident equity investors amounted to $1.33bn, but the week ending March 15 brought their largest weekly net sale, amounting to $106.5mn.

Election uncertainty weighs on capital flow
“Uncertainty in the run-up to local elections in Turkey at the end of this month has unfortunately weighed on the capital flow picture, with our daily tracker falling to the most negative since the EM sell-off in 2018. This deterioration explains some of the pressure on the Lira,” Brooks said on March 22 in a tweet.

Ash also observed in his trip notes email that ‘normalisation’ following the elections is “the buzz word in Ankara these days”, “meaning fiscal policy tightened, state bank lending moderated, structural reforms rolled out, and some of the non market responses to high inflation (price controls) ended”, and, also “a more orthodox monetary policy stance, which could still open the way for rate cuts this year if in the immediate period the lira is stabilised”, and “a deal with the US over the S400s”.

It seems Erdogan’s election bill will be a costly one. Certainly for ordinary Turks absorbing the economic shocks.

What is clear to Ash is that if the S-400 missiles are delivered as planned by Russia in July, then the US will sanction Turkey.

The S-400 issue is indeed a really tough matter to gauge given that two horse traders currently govern the US and Turkey. Some Turks are trying to sell the story of Ankara selling the missiles to a third party rather than installing them in Turkey. On the other hand, Erdogan seems determined to have them, maybe believing in the leverage they will give him.

Speculation is also mounting over which sanctions the US could impose on Turkey, but there is one clear conclusion; if even just talk of sanctions over the Pastor Brunson affair sent the Turkish economy heading for disaster last August, why should things be any different this time.

“Now the policy response should be for the CBRT to hike policy rates,” Ash unsurprisingly concluded, added: “[I]f the CBRT does not stabilise the lira now, and we see another bout of lira weakness, we end up back in the lira’s death spiral circa 2006, 2012/13, 2015/16 and worst of all 2018—higher inflation, more damage to banks and corporate balance sheets, and a deeper recession.”

“After all the [Erdogan ruling party] AKP and its MHP partner won, against expectations, the 2018 parliamentary elections and Erdogan won the presidency in the first round [re-election last year], again against all expectations,” he added.

Suffice to say here that the markets may well wonder at Erdogan’s mystifying ability to keep comfortably winning elections despite the odds set against him. But they also know this winner keeps paying high interest.

Post-election scenarios
Ash also posed some questions on post-election scenarios: “The question is what happens if the AKP-MHP coalition does poorly? Will this fundamentally weaken Erdogan, making him less willing to take the politically difficult and economically unpalatable decisions to ‘normalise’ policy after the elections which is now most people’s base and best cases (?) And will his [nationalist] MHP [parliamentary] coalition partner stay with the AKP, or pull its support risking early elections and yet another election cycle that Turkey absolutely does not need at this stage?”

Erdogan could ride out any public reaction against his “normalisation” policies as long as he holds on to his global recognition. It is not a secret that Syria’s Assad was being bombed by the Western coalition for destroying cities while the global media hardly batted an eyelid at Erdogan’s domestic fight against “terrorism”, waged at the cost of almost entirely wrecking some of his cities.

However, the question raised over the road that will be taken by MHP leader Devlet Bahceli is a billion-dollar one. In 2002, when the then coalition government was expecting to harvest some fruit from the IMF deal that followed the 2001 crisis, then Deputy PM Bahceli abruptly called snap polls. It was those elections that made Erdogan the PM with a parliamentary majority despite his party securing just 34% of the vote. All the parliamentary parties were punished by voters, pushing them below the 10% threshold for representation in the legislature.

We should also cast our minds back to election night of June 2015, when Erdogan lost his parliamentary majority. Bahceli once more called snap polls. And then there was Bahceli’s course of action following the failed coup attempt of June 2016. The MHP party chief called for the referendum that, on the official counting of the vote, narrowly delivered the constitutional changes for a “Turkish-type” presidential system, the country’s first executive presidency that has done away with the post of prime minister and rolled back parliament’s powers. Last April, moreover, it was Bahceli who demanded the snap parliamentary and presidential polls, which handily took place before most Turks could realise just how dire an economic morass they were headed for.

Bahceli’s only real concern is with Kurdish “terrorism”. Or perhaps we should translate that as “any kind of collective political rights for the Kurds”. He won’t make much trouble for Erdogan as long as his post-local-election “normalisation” policies do not include any softening up in the fight against Kurdish “terrorism” at home and abroad. However, it is Bahceli. He is fond of a big surprise. And it is Turkey. This is a country always liable to turn up any manner of surprise that changes everything in a split second.

AKP “has to retain… bastion of Istanbul”
Looking at what the Erdogan administration might accept as a good election result in the circumstances, Ash said “at a minimum, the AKP has to retain their hitherto bastion of Istanbul, and it would be better for the party to retain Ankara and Bursa. Losing all three would be a bitter blow to Erdogan and the AKP, but also important will be whether nationally the AKP/MHP coalition secures close to 50% of the vote. If their combined vote drops sufficiently close to 40% and the coalition loses all three of the cities mentioned above then Erdogan and the AKP would be in peril of a break with the MHP and therein losing its parliamentary majority and even splinters from the AKP—talk again of the likes of Davutoglu, Babacan and Gul leading some breakaway ‘reform’ AKP faction.”

“Erdogan is a shrewd political operator, a brilliant campaigner and reader of the mood of the Turkish nation,” in Ash’s eyes. Whether that mood would read rather differently if 95% of the Turkish media was not dominated by Erdogan is a question that should not go away.

Erdogan “can still pull a victory out of the bag on this one, surprising the pundits and winning the election,” according to Ash. Well, yes, but what the vote-counters have been pulling out of the bags in Turkey in recent years—let’s not forget the unstamped ballots the election watchdog has made a habit of giving its blessing to—has been rather peculiar.

Some curious data to end with
On a final note, here’s some curious data that bears further enquiry: the percentage of the central bank’s gold reserves held in Turkey rose to 80% at end-2018 from 17% at end-2017, Ugur Gurses pointed out on March 18 in a blog post based on the regulator’s annual report.

And Gurses has also noted, the national lender has employed $1.4bn of its USD reserves to buy gold reserves since Trump’s son-in-law Jared Kushner visited Ankara at the end of February, while the US Treasury paper in its portfolio declined to a value of $3.2bn at end-January from $61.2bn at end-November 2017. We can expect to hear more about that.