Analysts on March 20 were discussing just how endangered Turkey’s attempt at an economic turnaround is by the market shock and volatility caused by the detention of Ekrem Imamoglu, the popular politician seen as the main threat to President Recep Tayyip Erdogan continuing in power.

For two years, Turkish finance minister and ex-Wall Street Banker Mehmet Simsek has been luring foreign investors back to Turkey with what he bills as a return to economic orthodoxy that will eventually restore the country’s inflation-ravaged economy to health. But the volatility caused by the move against Imamoglu and the arrival of what seems to be an undeclared state of emergency was not long in showing—at one point, the Turkish lira (TRY) weakened by as much as 14% against the dollar, while circuit breakers activated at Borsa Istanbul could not prevent a substantial market decline. An unnamed central bank official, meanwhile, told Bloomberg that the authority sold about $8-9bn via public banks to stop the lira's slide. And the debt market hit was big. A 170-basis point sell-off was seen in the local currency bond curve.

Kaan Nazli, an emerging market portfolio manager with Neuberger Berman, told Reuters the events were "a serious blow to the investor confidence in the economic stabilisation programme".

Nazli also highlighted the risk of Turks being spooked into switching their lira savings into dollars or euros, just as has occurred during previous crises.

Francesc Balcells, FIM Partner's chief investment officer of EM debt, told Reuters that investors who have been attracted back to the Turkish market now needed to see aggressive central bank action to properly stabilise the lira.

The lira’s crawling peg, which has seen the currency drop around 1.5% a month on average, has underpinned "carry trade", with investment firms and hedge funds purchasing the government's local bonds that provide 40% interest rates.

"The thing about carry trades is that you need low volatility. When volatility spikes the economics of the trade are no longer there," Balcells was reported as saying, adding: "It is one of those things where you are picking up pennies in front of a steamroller. But today that steamroller has passed through big time."

William Jackson at Capital Economics said in a note: “The sharp drop in the Turkish lira on the news that the main opposition leader, Ekrem Imamoglu, has been arrested will complicate the central bank’s task of bringing inflation down and raises big questions about the government’s ability to sustain investor confidence in its macro reform agenda.”

“Turkish assets are under strong selling pressure,” Piotr Matys, senior FX analyst at In Touch Capital Markets, was quoted as saying by Bloomberg. “To some investors it’s also a reminder that President Erdogan intends to tighten his grip on power even more by attempting to prevent his biggest political rival from running in presidential elections due in 2028, although early polls can’t be excluded,” he added.

Veteran Turkey analyst Timothy Ash said in a post on his Substack blog that “there must now be fears over political and social stability”.

Looking at market impacts, he said “markets which had been positioned long lira (local and offshore) reacted badly, as expected, to today’s news. The lira dropped 14% at one point before recovering some of these losses. The concern then is obviously how this plays out in terms of the CBRT [Central Bank of the Republic of Turkey] disinflation process, and could this undermine the CBRT’s relatively new found independence? Actually on this front I think it likely reinforces Simsek’s position as Erdogan will not want a financial crisis to run alongside a political crisis.

“I expect the response from the CBRT to be very orthodox and I think we have already seen that so far this morning. Initially the CBRT let the lira find its own level, hence the 14% fall on the unexpected news, then likely followed this through with intervention, which pulled the currency back from the lows of 42 to the dollar to 38+. I think the CBRT will likely further intervene verbally in defence of the lira - perhaps suggesting that all options, including rate hikes, are on the table in defence of macro financial stability. The CBRT certainly has plenty of FX reserve ammo to defend the lira at this stage, with gross reserves now of well over $150 billion. But I think if lira weakness sustains, I think the CBRT will respond with rate hikes. I think the CBRT has the mandate to act, given the realisation that inflation is a major political liability for Erdogan.”

Ash also observed that rule of law concerns as regards Turkey were now set to “persist and this will likely damage longer term foreign direct investment flows – which are already low – unless the AKP administration is able to produce a compelling case against Imamoglu, et al.”