Erdogan Tanks the Turkish Lira

This week’s lira reduction was triggered by Mr Erdogan’s resignation of the head of the central bank on Saturday. The main sin of the deposed monetary maestro, Naci Agbal, was to wage an aggressive fight against inflation. He had raised the policy rate from 10.25% to 19% in an effort to stabilize consumer prices, which rose 15.6% year-on-year in February. Mr. Erdogan prefers economic growth regardless of the inflationary impact and seems to believe that higher interest rates lead to higher prices.

Mr. Erdogan’s poor economic management is not news. Turkey under his wing has gone through various types of crises, most recently with a fresh inflation spike turning into a currency crash in 2018. But this time, two differences stand out.

One is that investors had convinced themselves that Mr Erdogan had finally seen the light on economic policy and now claims to be surprised that he has not. The appointment of Mr Agbal in November, along with the resignation of Mr Erdogan’s son-in-law, who had been Secretary of the Treasury, was announced as a sign that skilled people would be in charge of macroeconomic policy. Still, Mr. Erdogan is Turkey’s biggest economic problem and guess what, folks, gambling is still going on at Rick’s.

The other new factor is the global economic climate, which is much less hospitable than during the last Turkish crisis two years ago. The pandemic is straining economies everywhere, and Turkey has been hit particularly hard by the travel collapse due to its reliance on tourism. With doubts about the summer holidays, especially for Turkey’s many European visitors, it is not clear how the country can earn its way out of the financial hole.

A constant between this and the 2018 crisis is more or less US interest rates. Subsequently, the Federal Reserve’s gradual hike in policy interest rates prompted investors from riskier markets such as Turkey to move into the US. Several other emerging markets also felt the sting.

This time, bond investors have hiked interest rates as they have rapidly increased yields on US Treasuries in recent months, and there is nothing orderly about capital flows as investors try to guess what kind of inflation could hit the US and what. Fed Chairman Jerome Powell could do something about it. As a result, the Turkish lira fell even before Mr Erdogan accelerated its decline over the weekend.

Global investors have become more critical of good and bad economic policies in recent years, so there is reason to hope that Turkey’s distress will not spill over to other emerging economies this week. But if US interest rates continue to rise, investors will start asking tough questions about the risks they are taking elsewhere in the world.