News reports have meshed Turkey’s currency crisis with diplomatic strains over the year-long detention of American pastor Andrew Brunson on terrorism charges. But as with much in Turkey, there are more layers to this story.

The convergence of events makes it difficult for those who do not follow Turkey closely to understand what caused its financial woes.

The Turkish lira lost 30% of its value against the dollar in only two days, on August 10 and 13. But it was already the world’s worst-performing currency, dropping by almost 50% against the dollar in the past 12 months.

It would be easy to blame the US and President Trump for Turkey’s economic woes, as recently re-elected leader Recep Tayyip Erdoğan has been doing. As a rule, Erdoğan does not like to accept   responsibility for any failure, so it was no surprise when he blamed the lira’s dramatic decline on an international conspiracy and appealed to his people to fight against a supposed “economic war”.

To be fair there was some support for this argument, as Trump levied sanctions on two Turkish ministers over “their role in the arrest of pastor Andrew Brunson” and accused them of “serious human rights abuses” after a Turkish court refused to release the American.

Then on August 10, the worst day for the lira, Trump announced via Twitter that the US would be doubling the tariffs on imported Turkish steel and aluminum. Erdoğan and Minister of Finance and Treasury Berat Albayrak, who happens to be his son-in-law, insisted that the Turkish economy had strong fundamentals and the fall of the lira was a result of manipulation and speculation by foreign enemies.

But even if political tensions contributed to the currency crisis, there is no escaping the fact that confidence in Turkey’s growth model has been deteriorating since 2013 due to its failure to address serious structural problems. In essence, Erdoğan has pursued a debt-driven growth model reliant on foreign funds since taking office in 2002.

On the face of it, the country’s growth has seemed impressive, averaging 5% in the past decade and reaching a peak of 11.1% in 2011. Last year gross domestic product (GDP) expanded by a solid 7.4%. But the flip side is an external debt of US$466 billion, or 60% of GDP, with 70% held by the private sector.

Debt reliance causing strains

Turkey also has a current account deficit equivalent to almost 10% of GDP, one of the worst in the world, as the export sector is dependent on imported intermediary goods. Adding to the payment pressures, capital inflows have been used to finance investments in so-called non-productive sectors like construction rather than for exports.

The model seemed to work well when the world’s central banks were pumping cash into international financial markets to soften the impact of the 2008 financial crisis. But since 2013, the US Federal Reserve and European Central Bank have been trimming the money supply and easing interest rates higher; Turkey did not prepare for the inevitable risks as the cost of financing its external deficit rose.

Financial markets took notice as the sovereign credit default spread, or risk premium, steadily climbed. Since the July 2016 coup attempt it has hovered between 250 and 300, and reached a record high of 475 in mid-August. By comparison, the US risk premium was 256.

The Central Bank of Turkey and the Banking Regulation and Supervision Agency were forced into rear-guard actions after the lira hit a record low of 7.3 to the dollar on Sunday night, pumping more liquidity into banks and limiting foreign currency swap transactions. The lira regained some of its losses, settling at 5.83 to the dollar.

But Erdoğan still reads the situation in diplomatic, rather than economic terms: Turkey is under attack from of its closest allies. The president warned last week that Turkey might be forced to look for other partners unless the Trump administration backed off.

Apparently acting on this threat, he has had phone conversations with other world leaders in recent days, including Russia’s Vladimir Putin and Germany’s Angela Merkel. But the most helpful contact was with the Qatari emir, Sheikh Tamim bin Hamad Al Thani, who flew to Ankara in a show of support. When they emerged from three hours of talks it was announced that Qatar would invest US$15 billion.

Qatar has long maintained close ties with Erdoğan. Last year, when Turkey was also in a currency crisis, it promised to invest US$20 billion, though there has been scant news about it since that time. Oil-rich Qatar, Bloomberg reports, has over US$335 billion in global investments, with a modest $1.68 billion finding its way to Turkey. The top sources of foreign direct investment are European countries, accounting for more than two-thirds according to official statistics.

Soaring inflation will hit demand

Turkey needs US$236 billion just to finance its current account deficit and external debt in 2018. Observers and analysts agree the Qatari announcement has had a positive impact on the lira, and that a $15 billion investment package would be very helpful in the short term.

The currency crisis has already taken a big toll. Central bank policy rates are not disclosed — with Erdoğan defying the advice of experts — but interest on Turkey’s two-year bonds rose to 28% after the currency intervention. Inflation is expected to hit 20% by the end of the year.

Since January the minimum wage has lost 85% of its value, dropping from US$425 to $240. External debt held by the private sector in lira terms has increased 20% since the beginning of August.

Albayrak assured foreign investors in a meeting that Turkey would take all necessary measures, including fiscal austerity and tightening monetary policies to get inflation under control. But such drastic responses would have severely curtail domestic consumption and production, adding to the current account strains and possibly leading to social instability.

The unemployment rate is already as high as 10%. Even though the lira’s value increased slightly on the back of the Qatari announcement, the cumulative structural problems and the impact of the currency crash will very likely cause a slowdown in economic growth next quarter and then a possible contraction, however much Erdoğan’s government chooses to ignore the risks.

Faik Öztrak, deputy leader of the opposition Republican People’s Party, known by its Turkish initials of CHP, took to Twitter to criticize the government’s handling of the economic downturn:

“If you were going to take these precautions and increase the interest rate, why didn’t you do it in the first place, before the $ rose over 7? Who sold their $ at these high levels and made profit out of that?

“In the old days there would be a full investigation against this management, but now Turkey is governed by one-man rule. No-one can question. No-one can be called to account,” Öztrak said.