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“As Lebanon proved, this strategy can last many years, even decades, but when the music stops the FX mismatches have to paid by someone, and in Lebanon’s case it is now mostly being borne by depositors,” Ash warned.
“So inflation is in double digits and sticky, the government continues to pump prime growth, which will feed a larger current account deficit, bringing a larger external financing requirement. This is being masked by the fun and games in the use/accounting of net reserves – it is being funded through spending the FX deposit base. But eventually the music will stop, and something will have to give again, in a repeat of 2018,” he also warned.
“Either the FX will have to adjust weaker, or policy rates will have to go higher to slow domestic demand and import demand with it. It is possible though with foreigners largely out of the market that this CBRT wheeze could last all year, and well through 2021,” he estimated.
Ash guesses the experience from 2018 is that we know the bubble will burst and its better for the CBRT to deflate it slowly through the neck using rates, but because of the political setting and Erdogan’s aversion to interest rates and usury, the balloon is more likely to be overinflated to bursting point, rather than gradually let down. Cleaning up the mess is then a much more difficult affair.
“Net-net, because of all the above foreign investors just don’t feel comfortable investing in the story. They are convinced the bubble will burst, but just do not know when, so would rather stay on the side-lines,” according to Ash.
“The loss of the $30bn tourism business, at least for this year is a real blow. It’s hard to see this business coming back quickly at least for this season. And obviously this puts added pressure on the BOP, and the exchange rate,” he also warned.
“There is ​always a lot of geopolitical noise in Turkey​ – we can think here of strained relations with the West over migrants, the situation in the Eastern med, the Gulen issue, the Kurdish issue, ...democracy and human rights are under threat from the Erdogan administration, Russia (S400s), Iran sanctions busting (the Halkbank issue) and Syria, amongst others... Relations are also strained with some Gulf states (Saudi Arabia, the UAE) and Egypt over Turkey’s support for political Islam, latterly in Libya. And more recently the warming in relations with Russia has gone into reversal as tensions also emerge over Syria, Libya and now the Hagia Sophia mosque issue also,” he recalled.
“It is probably fair to say that on some levels relations with the US and the EU are the worst they have been in a decade or more. And yet despite all that – and plenty of talk of imminent sanctions being imposed on Turkey by the US for the Halkbank issue and S400s – the West has done little in effect to sanction the Erdogan administration. Some might argue that Erdogan has played the West well, and in particular he has utilised the seemingly strong personal bond between Erdogan and Trump, and the two respective first families, to counter sanctions pressure from the DC establishment,” he noted.
“Similarly, with regards to the EU, Erdogan seems to have read well that the EU needs Turkey more than the other way around on issues such as NATO defence (Turkey still has the second largest standing army in NATO) migrants, Syria, Libya and fighting Islamic terrorism,” he also wrote.
“Perhaps the biggest risk to the above comes from looming ​US elections​,” he warned.
Ash thinks ​it is not by chance that foreign direct investment is running close to 20 year lows​ – and he thinks you can chart the decline therein from the peak of 2006/07 when Turkey was on a track to EU membership, and
30​ TURKEY Country Report​ August 2020 ​ ​www.intellinews.com