U.S. President Donald Trump, right, shakes hands with Recep Tayyip Erdogan, Turkey’s president. (Photographer: Michael Reynolds/Pool via Bloomberg)

Turkey's Fragile Economy Faces New Risk in U.S. Sanctions Threat

(Bloomberg) -- Already hit by a run on the currency and a surge in inflation, Turkey’s economy faces a new risk after President Donald Trump threatened to impose “large sanctions” over the detention of an American pastor.

Trump’s warning followed criticism of Turkey by his vice president and secretary of state, and caused the lira to extend losses in late trading. The U.S. diplomatic offensive was aimed at securing the release of Andrew Brunson, an evangelical minister detained on charges of involvement in a failed 2016 coup in Turkey. He was moved from jail to house arrest earlier this week. But that didn’t satisfy Trump, who demanded on Twitter that “this innocent man of faith should be released immediately.”

Turkish officials insisted that the matter was one for national courts. Ibrahim Kalin, a spokesman for President Recep Tayyip Erdogan, said America’s use of “threatening language” against an allied nation was unacceptable.

The latest in a series of crises between the NATO allies comes at a fragile moment for Turkey’s economy, which depends for financing on short-term flows of international capital, or “hot money,” that are typically sensitive to disputes with the U.S.

‘It’s a Target’

Before his re-election last month, Erdogan alarmed investors by promising to increase his control over the central bank, which he’s repeatedly attacked for keeping interest rates too high. When the bank unexpectedly decided not to raise rates this week, it exacerbated those concerns. And Trump’s sanction threats were the latest blow to the lira, which has fallen more than 20 percent this year, making it the second-worst major currency after Argentina’s peso. It dropped another 1.9 percent on Thursday to 4.87 per dollar, near a record low.

Broader U.S. sanctions against the Turkish financial system “would be devastating, catastrophic,” and even measures that targeted a few individuals would have an impact, according to Jonathan Schanzer, senior vice president at the Foundation for Defense of Democracies in Washington, who previously worked on sanctions-related issues at the U.S. Treasury.

“Banks will know that Turkey is susceptible to U.S. sanctions, that it’s a target,” Schanzer said in an interview. “That’s why you saw the response of the lira that you saw today. Even the threat of sanctions prompts capital flight.”

Other arguments are raging between the two NATO allies. The U.S. has slammed Turkey for violating Iran sanctions and negotiating to buy missile defense systems from Russia, issues that are both likely to incur separate financial penalties. The countries have also clashed over the war in Syria, where Turkey has increasingly acted in concert with Russia and Iran.

Erdogan blames the U.S. for backing Kurdish militants in Syria, and harboring the alleged mastermind behind the coup attempt against his government.

Magnitsky-Style?

Neither Trump nor the White House offered any immediate details about economic measures that the U.S. may take, or how soon they may be imposed.

Erdogan’s government arrested Brunson in 2016 and indicted him last year on charges of espionage and attempting to overthrow the state. On Wednesday, after a year-and-a-half in jail, he was released to house arrest. But that move didn’t assuage U.S. anger, because the American side had been expecting him to be sent home under an agreement that broke down.

Some analysts have raised the prospect that Trump or the U.S. Congress could impose measures targeting business leaders close to Erdogan’s government, along the lines of American sanctions against Russia.

When, Not If

The U.S. Senate Foreign Relations Committee on Thursday approved a bill that would commit the U.S. to opposing any credit offers to Turkey by international lenders such as the World Bank’s International Finance Corp. Similar legislation also was introduced in the House of Representatives, though any final action in either case would be st least several weeks away.

Under normal circumstances, the direct impact of any U.S. measures might be limited. Medium-sized economies like Turkey typically aren’t materially hurt by sanctions unless they’re very stringent, according to Neil Shearing, chief emerging-market economist at Capital Economics in New York.

The problem for Turkey is that it’s already feeling financial strains. Erdogan ran the economy hot in the build-up to elections, and there’s concern that it could now pay a price. Inflation hit a 15-year high last month, while Turkish companies that borrowed in dollars and euros are finding it harder to pay those debts after the lira’s slump.

Turkey “always flashes red on external-financing vulnerabilities,” Shearing said. “I wouldn’t overplay the specific risks from sanctions, but Turkey’s economy is not in a good place. A severe adjustment looks like a matter of when rather than if.”

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