(Bloomberg) -- Turkey has been through a lot over the past few years: a coup attempt, a divisive referendum that concentrated more power in the hands of President Recep Tayyip Erdogan, and spillover from the Syrian civil war on its southern border. But all that doesn’t explain why the lira keeps coming under pressure during every major global selloff. Behind five consecutive years of depreciation is an unbalanced economy that must rely on foreign capital.
1. What’s been happening to the lira?
It’s been one of the hardest-hit emerging-market currencies, shedding more than 21 percent of its value against the dollar this year. The only currency to fare worse among major peers is the peso in Argentina, where the central bank was forced to raise interest rates and the International Monetary Fund was called in to provide emergency funding.
2. What’s spooking investors?
Investors complain that Turkey’s economy is overheating and its monetary policy has been too loose to contain runway inflation. Turkey’s also burdened by twin deficits. Its budget deficit has been exacerbated by a fiscal boost ahead of elections in June. Its current-account deficit -- a broader measure of a nation’s imbalance in trade -- has ballooned to more than 5 percent of output, among the largest in the G-20 group of nations. That makes the lira particularly vulnerable to capital outflows. When times are good and investors are happy to take risk, money flows into Turkey, supporting the currency. When the mood sours and inflows slow, as they have recently, the lira buckles.
3. Why is Turkey’s current-account deficit so large?
Part of the problem is that Turkey lacks energy resources and is a major oil importer, which means the long rally in crude prices has inflated the bill. Turkey’s low savings rate means that breakneck growth -- the economy grew faster than China in 2017 -- has to be financed with money borrowed from abroad. Making matters worse, the bulk of the cash coming in is in the form of short-term portfolio flows into stocks and bonds, as opposed to more stable and desirable long-term investments in companies and factories. To make sure the money stays, Turkey’s central bank needs to make sure that interest rates are high enough to lure investors -- something it has appeared reluctant to do.
4. Why the reluctance?
The problem is that Erdogan, who has made himself Turkey’s most powerful leader since its founder, Mustafa Kemal Ataturk, supports lower rates. He has his own ideas on what causes inflation, and in a recent Bloomberg TV interview, he said he plans to take more responsibility for monetary policy if he wins an election in June. Investors worry that persistent political pressure from the government makes the bank resist taking action until the market forces an increase. That’s what appeared to happen on Wednesday. In an extraordinary meeting of its monetary policy committee, the bank raised interest rates by 300 basis points to 16.5 percent to halt a slide that saw the lira post a series of record lows.
5. Will higher interest rates solve Turkey’s problems?
Not all of them, but higher rates could put the economy on a more sustainable path. The economy should cool, imports should slow and the current-account deficit should narrow. Turkey should need to borrow less, giving some relief to the lira and to Turkey’s corporate sector, which sits on foreign currency-debt equivalent to 40 percent of gross domestic output. On the downside, higher rates will probably leave some borrowers unable to service their debts, so non-performing loans at banks will likely rise. To keep unemployment down in such a scenario -- it’s hovering at around 10 percent now -- Turkey will need to transition to a production- and export-led economic growth model. That’s easier said than done.
6. Is there a long-term solution?
Yes, structural reform of the economy. That means politically costly but long-overdue economic reforms to increase competitiveness, boost savings, and invest in education and technology that will help increase production of more valuable goods, boosting export revenue. Only then would the lira break free from its reliance on fickle flows of foreign capital.
The Reference Shelf
- A rushed meeting of government leaders didn’t help the lira for long.
- The lira’s weakness has helped spoil what could have been a record year for initial public offerings in Turkey.
- QuickTake explainers on Turkey’s political, religious and geographical divides, Erdogan’s ideas about interest rates and central bank independence around the globe.
- Turkey is about to have the most pivotal election in its modern history.
- Back in 2015, Quartz reviewed the lira’s "long tale of woe" under Erdogan.
©2018 Bloomberg L.P.