OPINION: Will Turkey’s capital flight trigger another currency crisis

Erdoğan made a historic mistake by ordering the arrest of İmamoğlu, losing a significant amount of political capital. Since that day, polls have shown the AKP trailing behind the CHP, with 60–65% of respondents opposing İmamoğlu’s removal by fraudulent means. Street protests erupted to protest Erdogan, wtih CHP declaring war on him.   Erdoğan’s historic miscalculation also dropped a ticking time bomb in the lap of the Central Bank of Turkey (CBRT). Since then, CBRT’s net reserves have shrunk by approximately $40 billion.

While most foreign investors concluded that “this country is not investable” turning to other Emerging Markets (EM), locals also rushed to foreign currency in panic, rightfully unsure of where this crisis would end.

If you’ve read my previous articles or watched the linked video, you’ll know how pessimistic I am about politics. Erdoğan has, for now, shelved his plans to appoint a trustee to Istanbul Metropolitan Municipality and the CHP, but as soon as public anger calms, he’s expected to put those plans into action.

Since İmamoğlu’s detention, he has twice more threatened the CHP with legal action, while investigations have been launched into the municipalities of Zonguldak and Beykoz (Istanbul).

So, will this flight to foreign currency continue, and will Turkey once again wake up to a currency crisis one morning? Let’s try to answer those questions.

This article is composed of three parts.

First, I’ll explain other causes behind the rush into foreign currency.

Second, we’ll weigh how political risk influences depositor behavior.

Lastly, I’ll offer a prediction on the CBRT’s interest rate decision on Thursday and how it might affect the FX vs. lira choice.

Turkey didn’t experience just one, but four simultaneous shocks.

Since İmamoğlu’s detention—coincidentally—capital outflows from Emerging Markets began:

“According to the Institute of International Finance (IIF), emerging market equities and fixed income assets saw a net foreign outflow of $17.1 billion.

This marks the first time flows turned negative since Donald Trump won the U.S. election in November, and it’s the largest monthly outflow since August 2023.

Equities saw $12.4 billion in outflows, nearly three-quarters of which came from Chinese stocks.

Losses in the bond market were driven mostly by $6.7 billion in outflows from Chinese fixed income, outweighing the $1.9 billion of inflows into other EM bonds”.

According to Bloomberg’s report, capital flight from EMs continued in April. In other words, at a time when political shocks roiled Turkey, demand for  EM assest were already low.

The second shock was journalist Nuray Babacan’s report that Gaye Erkan might be appointed to head the Presidential Investment Office. Those who know Erkan suspected that Mehmet Şimşek’s position might be in danger, so they bought even more foreign currency.

The final blow came from the Capital Markets Board (SPK). A new rule required Money Market Funds (MMFs) — designed to invest only in O/N and TLREF assets — to hold 10% of their net assets in government bonds. Investors, who had parked $40 billion in these funds, woke up to realized losses. Cursing the move, they sold half of their MMF holdings and moved much of it into FX.

New shocks from the Trade War may continue to rattle EMs, but Turkey won’t be much affected anymore — most foreign funds have already left. Since Turkey  is only watching the Trade War from the sidelines, it’s unlikely that such shocks will trigger further FX flight here.

Also, Gaye Erkan was not appointed, and there’s no indication that Şimşek’s job is at risk.

With yields on government bonds peaking, MMFs that buy them will now record profits, attracting investors once again.

For individuals, staying in foreign currency has an unbearable cost.

Newspapers reported yesterday that deposit rates surged to 50%. FX returns are zero, while monthly TL returns are around 4%. Can political uncertainty keep people in foreign currency despite this massive return gap?

If protests turn violent — yes. But I think Erdoğan will wait for tensions to calm down naturally in summer as colleges co into recess, while migration across the nation to tourism and agricultural jobs will mitigate prospects of large rallies. As I said earlier, he won’t make further moves against the CHP until the current shocks subside. In short, while political risk persists, we’re not yet at peak risk.

On the positive side, summer is approaching. Even though the CBRT lost $40 billion in reserves during this crisis, seasonal current account surpluses in the summer will allow it to replenish reserves and steer the exchange rate.

So, at least until November — when the tourist season ends — FX demand from households is unlikely to spark a currency shock.

Now to the final part: What will the CBRT do on Thursday, and why does it matter?

Surveys suggest the CBRT will hold interest rates steady, which would encourage a return to TL. There’s widespread belief that Erdoğan was behind the premature rate cut in December. If the CBRT cuts rates again on Thursday, it’ll confirm fears that we’re back to “Nass days” (religious justifications for low interest). Even if citizens don’t buy more FX, they’ll hoard what they have, laying the groundwork for a winter crisis.

However, if the CBRT keeps rates unchanged, which is concensus forecast, it’ll signal that Erdoğan is no longer intervening, encouraging people to return to the lira.

My esteemed colleague and HSBC Portfolio Chief Economist İbrahim Aksoy made an even bolder prediction yesterday:

“Based on CBRT data, our calculations indicate that net reserves adjusted for swaps continued to decline on Wednesday. Excluding public sector FX deposits at the CBRT, net reserves fell by another $1.5 billion to $12.7 billion.

The CBRT will announce its interest rate decision at 2:00 PM on Thursday.

Due to the pace of reserve depletion, we expect the Monetary Policy Committee (MPC) to raise the weekly repo rate by 2.5 percentage points to 45.00%, and the overnight lending rate to 48.50%.”

It is bold call, but I disagree — because raising rates could tip the already slowing economy (based on February–March data) into a shallow recession. And Erdoğan doesn’t want a recession when the public is already this angry.

But if Aksoy is right, and rates are raised, we might also see hot money rushing back into the system just as quickly as it left.

By Atilla Yesilada, Editor in Chief