PA Turkey

I’ve suffered insomnia since the beginning of the Century, which is now compounded by the Iran War, which I shall call by its real name, namely Gulf Crisis. I suddenly wake up in the middle of the night, as I’ve done half an hour ago (it is 2 am Saturday in Turkey) to watch or read about all the developments in the Gulf Crisis, how minute these may be. I think the phrase for such obsessive behavior is nowadays called “doom scrolling”, but I call it “war porn”, because it is an addiction like porn which becomes an all-consuming passion with no real benefit to the mind or soul.

And, what have I concluded from endless hours of studying the Gulf Crisis? That the talks in Pakistan will not lead to a lasting ceasefire. Hostilities will start next Saturday, and last until Iran and Israel run out of projectiles to club each other with. Despite this necessary pause, by then the causes of the crisis will not have been resolved and the various supply shocks triggered by it will undermine global economic resilience for at least another year to come.

Actually, this article is about CBRT’s reserve burn and the majority view among Turkish economists that TL is vastly overvalued and defending the currency is futile. Either the exchange rate should be abandoned to market forces, or CBRT should overnight devalue TL vs USD by 25% or so to avoid a Balance of Payments (BoP) crisis.

I will admit that I’m a mediocre economist who only remains a minor celebrity in Turkey, because I’ve been trained in finance and have been doing political analysis for 35 years, so a Jack of all trades. My thesis is very simple: While the current strong TL policy exacerbates the overvaluation of the TL at a time of a huge terms-of-trade shock devastating exports, which is certainly a problem that needs to be dealt with, it pales in comparison to letting the TL fall vs USD to its “equilibrium level”. Doing so would trigger a massive inflation shock and severely undermine Erdogan’s already frayed standing with voters.

Of course, political necessity is not economic policy. The big question is whether CBRT can defend the strong TL policy, in my Gulf Crisis scenario briefly outlined at the beginning: The kinetic phase lasting through April and the supply shock lingering for another year.

The simple answer is yes, CBRT can defend the currency at artificially overvalued levels until after the next election, whenever this may take place. This is where my understanding of finance comes into play. Currently, roughly 40% of deposits in the Turkish banking system are in FX. There was no new FDI over the last three years, while “hot money” amounted to $40–50 billion in the system, most of which departed Turkey asap. As long as CBRT can keep Turkish depositors in TL assets (that is prevent further dollarization), it can always replenish its FX reserves by borrowing them from banks for TL, that is doing currency swaps. In fact, even if dollarization increases to 50–60% of total deposits, this conclusion doesn’t change. The only reason why CBRT will run out of reserves is Turks withdrawing funds out of the system, that is; a typical bank run.

By the way, I’m not spouting out theory here. For different reasons, Turkey has been in this situation several times in the recent past. Remember Pastor Brunson crisis with the US? Remember 2019 election, before which CBRT burned through ca. $120 bn of reserves to defend the currency? Remember December 2022, when letting the currency fall wherever it might fall led to a huge devaluation and the invention of the completely crazy FX-protected deposit scheme? Remember the run-up to 2023 dual election, when CBRT net reserves fell as low as minus $70 billion? These cases give us a very solid baseline to comprehend that CBRT has many tools in its kit to prevent devaluation of the currency and a BoP crisis. In 2023, when its gross reserves fell to dangerously low levels, CBRT simply instituted concealed capital controls. Essentially, what I’m saying is that the CBRT has the muscle memory to deal with huge pressures on the currency and come out victorious.

Yet, like Trump, Erdogan is extremely unpredictable and erratic in his policy choices. Persuaded by the cheap TL lobby, he can instruct CBRT to undertake a one-off 25% devaluation of the TL vs USD. I think he is smart enough to know that such an act will lead to a voter revolt, but I can’t rule it out completely. Secondly, a domestic political crisis, like the arrest of CHP chair Mr Ozgur Ozel, could precipitate a massive sentiment shock, compelling Turks to run on the TL. This is possible, but not too probable, because every foreign or domestic investor I talk to fully expects this to happen. In other words, Erdogan bulldozing over CHP is currently priced in the exchange rate.

So, don’t pay any attention to doomsayers. The strong TL policy is here to stay for the foreseeable future and given that there is no effort to cut budget expenditures or initiate structural reforms, it is the only viable defense to prevent another episode of runaway inflation.

Atilla Yesilada, columnist and Global Source Partners Turkey advisor.