Turkey’s battered lira weakened more than 6 percent against the dollar on Friday, Aug. 17, after a U.S. warning that Ankara should expect more economic sanctions unless it hands over the detained American evangelical pastor Andrew Brunson.
Brunson, called a “great patriot hostage” by President Donald Trump, has spent the better part of the past two years in Turkish prisons or other forms of detention, over alleged links to outlawed political groups.
The dispute over his release has put the two NATO allies at loggerheads, sparking an escalating tariff tit-for-tat.
The Threat of New US Sanctions
U.S. Treasury Secretary Steven Mnuchin told President Donald Trump at a cabinet meeting on Aug. 16, that sanctions were ready to be put in place if Brunson, who faces terrorism charges, was not freed.Trump later said in a tweet the United States “will pay nothing” for Brunson’s release, “but we are cutting back on Turkey!”
Turkish officials say the case is a matter for the courts and vow not to fold under U.S. pressure.
Last week, the United States doubled its tariffs on metal imports from Turkey.
A Turkish court refused to release Brunson, and the government in Ankara raised tariffs on a range of U.S. goods–cars, alcohol, and tobacco.
Erdogan also said on Aug. 14, that Turkey would boycott electronic products from the United States, vowing to substitute foreign imports with domestically produced goods.
”We will impose a boycott on U.S. electronic products. If they have iPhones, there is Samsung on the other side,” Erdogan said at an assembly of his AK Party members in Ankara.
Turkey ‘Ready for War’
Erdogan has leveled accusations against the United States of trying to “bring Turkey to its knees.”It was unclear whether Erdogan was referring to a trade war, or whether he was making a statement about military preparedness.
“The secret to successful states is their readiness for war. We are ready with everything we have,” Erdogan said, according to Ahval.
“It is everyone’s observation that the developments in foreign currency exchange have no financial basis and they are an attack on our country,” Erdogan said.
The Turkish lira has lost nearly 40 percent of its value against the dollar this year.
The currency crisis has deepened concerns about weaknesses in the broader economy—particularly Turkey’s dependence on energy imports and whether foreign-currency debt levels pose a risk to the banking sector.
Rewriting the Crisis-Management Playbook
The crisis in Turkey follows a standard formula for how crises in emerging markets play out.The usual suspects are: over-reliance on foreign-currency borrowing to drive economic growth, concerns by investors that central bank policy is prone to political gerrymandering, and a drying up of liquidity globally, caused in part by capital flight to the safe haven of the dollar, made more lucrative due to raising interest rates in the United States.
The standard emerging-market response is to seek an external funding anchor—such as a line of credit with the International Monetary Fund—and interest rates to attract investment in the weakening currency.
Higher interest rates and potentially stringent IMF funding conditions typically mean some order of unpopular austerity, which carries a political risk for leaders reliant on keeping voters happy through lax monetary policy.
Turkey has vocally rejected both measures–raising rates and the IMF backstop–opting instead for an unconventional mix.
Turkey has mobilized $15 billion from Qatar for direct investment.
Other measures include promising to curtail credit and fiscal excesses and disavowing capital controls to reassure investors the government won’t seize foreign-denominated assets.
But economists have said they want to see decisive moves by the central bank, rather than technical measures.
Turkey and its firms face repayments of nearly $3.8 billion on foreign currency bonds in October, Societe General calculated. For companies, the cost of servicing foreign debt has risen by a quarter in lira terms in the past two months alone.
Ratings agency Standard & Poor’s is scheduled to release a review of Turkey’s sovereign credit rating after the market close on Aug. 17.
“It is possible, but not probable,” El-Erian says.
There are flaws with Turkey’s gambit, including the fact that the funds from Qatar are not as reliable a proposition as IMF-branded liquidity, and they are small relative to Turkey’s external funding needs.
And time is running out for Turkey as it tries to write a novel chapter in the crisis-management handbook.
“It is unlikely that a critical mass of corrective steps has been attained in Turkey,” El-Erian says.
“While the domestic policy adjustments provide short-term relief for the currency, they may be neither comprehensive nor sufficient as yet to return Turkey to a promising path for inclusive economic growth and durable financial stability.”
Turkey’s best course of action, El-Erian says, is for Ankara to “seek a way to pause the skirmish while working on the longer-term underlying issues.”
Experts say markets need more than technical remedies like the central bank’s promise to provide emergency liquidity to banks, or the government’s promise not to seize dollar-denominated bank deposits.
For one, raising interest rates is needed to calm markets and stem the lira’s sell-off.
“What you want to see is tight monetary policy, a tight fiscal policy, and a recognition that there might be some short-term economic pain—but without it there’s just no credibility of promises to restabilize things,” said Craig Botham, Emerging Markets Economist at Schroders.
Economists warn the currency crisis could spill over into full-blown economic recession.
“The plunge in the lira, which began in May, now looks certain to push the Turkish economy into recession,” Andrew Kenningham, chief global economist at Capital Economics, told Reuters.
Turkey is dependent on imports, priced in hard currency, for almost all of its energy needs.
For years Turkish firms have borrowed in dollars and lira to take advantage of lower interest rates.
But now, the sell-off has increased the cost of servicing that debt, particularly for companies whose revenues are solely in lira.
Turkey has the highest foreign exchange-denominated debt among emerging markets, Societe Generale said in a note on Aug. 17, estimating its short-term external debt at $180 billion and total external debt at $460 billion.
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