The Turkish lira entered its latest cycle of record-breaking lows after the US announced sanctions targeting Turkey’s justice and interior ministers amid a row over the detention of US Pastor Andrew Brunson on August 1. Ankara retaliated with tit-for-tat sanctions. 

Markets were again desperately hoping for a positive outcome from a visit paid by a Turkish government delegation to Washington on August 8, but several media reports late in the day said that talks had failed to break the impasse over Brunson, who is under house arrest in Turkey on terrorism and espionage charges

Consequently, the lira continued to sink to all-time lows on August 9. The current record low against the US dollar stands at 5.4488. The local currency was trading at 5.3928 as of 13:00 local time on the day, a weakening of 2.13% against the closing rate of the day before.

Meanwhile, the markets have for a few days been hooked on discussions as to which options Turkey still has to pull itself out of the current meltdown, with criticism over Turkish officials being “missing in action” also rising.

On August 9, the Turkish treasury and finance ministry said in an emailed press release that President Recep Tayyip Erdogan’s son-in-law and recently appointed Finance Minister Berat Albayrak would announce a new Turkish government economic model on August 10.

According to the statement from the ministry, the government now expects GDP growth to slow down to 3-4% in 2018, the first signal from the government that it is getting ready to cool down the overheated economy. The ministry, meanwhile, said that it saw no FX or liquidity risk for Turkish lenders and corporates, signalling that the government was still avoiding the country’s growing economic problems.

“Albayrak needs to be on the road, talking to investors and bankers”
“I don't understand why [Albayrak] cannot just speak now. You released the statement, read the statement. They need to be more proactive than this. Albayrak needs to be on the road, talking to investors and bankers constantly — re-assuring, listening. He needs to really understand the massive challenges that Turkey faces, and it’s a 24/7 job at this point in time — you cannot be an anti-crisis manager, ‘by appointment only’,” Timothy Ash of Bluebay Asset Management insisted during his days-long criticism over Turkish officials’ lack of action. 

In addition to the slowdown in 2018 GDP growth, the ministry also predicted in its statement on August 8 that the budget deficit would fall below 2% of GDP this year.

“Good news if true. But does the market trust Albayrak to deliver?” Ash said in a separate e-mailed comment, adding “It would be good to see them being proactive about all those bad debts in the energy sector — maybe creating a bad bank to work these out and ease concerns over rising [non-performing loans] NPLs in banks. I guess Albayrak should understand the challenges in the energy sector given he was minister of energy.”

“The lesson from other countries that have suffered from currency crises is that fiscal and monetary policy will need to tighten, preferably under the auspices of an IMF deal, to stabilise the economy. However, it’s unclear that this is politically palatable in Turkey. It seems more likely that the government will try to muddle through for as long as possible, resulting in further currency weakness and higher inflation,” William Jackson of Capital Economics said on August 9 in a research note entitled "How can Turkey get out of its crisis?".

Some analysts have been voicing the possibility of capital controls, but Capital Economics’ sense is that this is unlikely. Ash also weighs on the IMF choice rather than the capital controls as he believes Erdogan has proved during his 16-year-long rule that he is able to employ dramatic U-turns, which this time should probably include such compromises as the release of all jailed US citizens in Turkey or realigning with the Western bloc in international politics.

“Capital controls tend to be most effective in countries with a well-established framework for monitoring such transactions (e.g. China). They also seem more likely to work when aimed at preventing residents from moving money abroad rather than preventing non-residents from selling local assets. In Turkey’s case, most capital flows involve non-residents’ transactions in Turkish assets. Any restrictions on these would cause capital inflows to dry up and limit Turkey’s ability to fund current account deficits in the future,” said Jackson, supporting the “no capital controls” route.

Turkey’s main problem is seen as its overly loose monetary and fiscal policy that fuelled GDP growth, but at the cost of booming inflation and a surging current account deficit, both the largest by quite a long way across the major emerging economies. Also sounding alarm bells is that, while the local currency has been nosediving amid political worries combined with the roaring inflation and current account headache, the central bank’s FX reserves are fairly limited.

“The most recent news suggests fiscal policy will be loosened. Our base case, then, is that Turkish policymakers will try to muddle through for as long as possible, resulting in higher inflation and a weaker lira. Sporadic currency crises and rises in interest rates are likely,” Jackson also said, adding: “We suspect it would take a much more severe economic crisis, probably involving problems in the banking sector, to change direction. Such an outcome is a distinct possibility. But it would imply that economic conditions would need to get much worse before they got better.”

Meanwhile, the silence of Turkish government officials also makes markets wonder whether Turkey has alternative financing sources to the West which currently provides around two-thirds of its trade, finance and FDI.

Ash thinks the Chinese would be cautious about deploying large amounts of capital to Turkey although they promised $3bn-5bn worth of loans at the latest BRICS summit. He also doubts that enough of Turkey’s close ally Qatar’s more than $300bn worth of sovereign wealth fund assets is liquid enough to provide the tens of billions of US dollars which would make a difference to Turkey at this stage.

On the contrary, as David P. Goldman speculated in his latest column entitled “Who’s going to buy Turkey?” for Asia Times: “[Currently] $33bn worth of BIST-30 index is a rounding error in China’s global net asset position, and the likeliest outcome of the crash of [Recep] Tayyip Erdogan’s kleptocracy is that Turkey will simply be a wholly-owned subsidiary of China. 1,500 years after the Han dynasty kicked the Turks out of Central Asia, it will buy them out as well.”

“Inshallah I am wrong, Inshallah we have alternative strategies,” Aydin Unal, a former MP from the ruling Justice and Development Party (AKP) and former advisor to Erdogan, wrote in his latest column for pro-Erdogan daily Yeni Safak after he narrated how “damned markets” supported the 16-year long AKP rule when the government played within the market’s rules.

Ege Cansen, a columnist for daily Sozcu, hoped “the ones simultaneously conducting policies of fighting with the West and not appealing to the IMF know what they do”. For Cansen, “the only explanation could be shifting to a growth model without giving current account deficits that would result in significant depreciation of the local currency and erosion in real incomes.”

Observers also speculated as to whether Erdogan had some alternative strategies after he told Bloomberg TV in London on May 15 that he planned to tighten his grip on the economy and assume a greater role in setting monetary policy if he was kept in power in the upcoming snap election. However, not long after, the Turkish central bank was pushed by the sharp depreciation in the local currency to hike policy rates by 300bp in an unscheduled emergency meeting.