On the eve of Sunday’s local elections, Turkish President Recep Tayyip Erdogan is doing everything in his power to postpone impending economic grief for his constituents.

On Monday, Turkey witnessed yet another unprecedented measure aimed at preventing a currency crunch. Economic authorities are understood to have pressured Turkish banks not to lend the struggling national currency to foreign financial institutions.

As a result, the liquidity of the Turkish lira dried up in foreign markets overnight, while the cost of offshore borrowing in the currency rocketed by more than 1,000%. The move was aimed at stemming the lira’s trend of dropping against the dollar, as well as convincing voters back home that foreign interests would have hurt the economy otherwise.  

As a result, foreign investors began to dump Turkish assets, bonds, and stocks, which led to a 6% plunge on the Istanbul Stock Exchange within 24 hours – its biggest drop in a single day since July 2016.

Still, the dollar sank to a level of 5.3 against the Turkish lira as intended – but the boost was short lived. The dollar started strengthening again the next day, eventually rising higher than before the economic gamble – to 5.5 to the lira.

On March 22, data from the Central Bank of the Republic of Turkey showed that net foreign-exchange reserves were down to $21.7 billion from $29 billion in the first two weeks of March. Some analysts even calculated that reserves have fallen to as low as $9.8 billion.

Economic observers suspect that the missing $7.3 billion was sold secretly by public banks in order to prop up the value of the lira before the vote. The central bank has yet to provide an explanation regarding the sudden drop in foreign reserves.

Turkey’s $28.6 billion current account deficit and its $448.5 billion gross external debt – a quarter of which is short term – make the country’s foreign reserves critically important. An investigation has reportedly been launched against JPMorgan Chase & Co for predicting a decline in the lira. Related news reports triggered a move against the Turkish lira, with the exchange rate hitting 5.8 lira against the US dollar.

Figure 1: Dollar against TL in March 2019

Erdogan was clearly set on averting a fresh currency crunch ahead of elections. But if his son-in-law, Minister of Economy Berat Albayrak, and other authorities expected this experiment to maintain the value of the lira through Sunday, they were wrong.

The original experiment backfired, and the dollar actually strengthened while interest rates rose. A currency crunch may have been averted, but it was accompanied by higher interest and exchange rates, as well as major losses in the stock market.

Figure 2: Interest Rate of 2-Year Turkish Bond (Source: Bloomberg)

A political gamble

Erdogan knows from first-hand experience that economic problems can threaten his hold on power.

His Islamist party, the AKP, came to power in 2002, one year after a major economic crisis. Turkish voters punished the coalition of parties responsible for the crisis, leaving them with less than a 10% presence in parliament and championing the newly-founded AKP – the successor to another political Islamist party, Refah – with 34% of the vote.

Since then, Erdogan has succeeded in holding together his supporters with an ever-increasing nationalistic tone, polarizing society and feeding fears of instability originating from within and without, consistently controlling the opposition with undemocratic measures.

Faced with a currency crunch in August 2018, Erdogan – as usual – did not take any responsibility. He blamed US President Donald Trump and other foreign enemies for seeking to undermine Turkey’s power through “an economic war,” He then employed stop-gap economic measures to keep up appearances among his most loyal supporters. The last economic experiment was the most creative example of this.

With Erdogan fully in control of the mainstream media, opposition parties are left with limited channels to reach voters, and the Turkish leader has made sure opposition parties cannot raise economic issues.

In the final weeks of the election campaign, Erdogan hardened his language, accusing opposition party candidates of having ties with terrorists. In recent days, the president openly said that if his rivals are elected, they will not be allowed to govern. The Minister of the Interior even publicized police reports on several opposition candidates supposedly having terror ties.

These threats from the president did not come as surprise to anyone. He has undertaken similar actions before. Erdogan in 2017 appointed trustees in the place of “terror-linked mayors” from the Peoples’ Democratic Party (HDP), the second-largest opposition party, after its strong performance in the Kurdish-majority cities of southeastern Turkey. He is now threatening all opposition parties, raising concerns about the sanctity of the election.

Prestige at stake

Even though Sunday’s elections are only local polls, Erdogan is treating them as if he is the one on the ballot and his government has employed a wide range of measures to postpone the impacts of an impending economic crisis.

These fiscal and monetary policies include tax cuts, employment subsidies to companies and cheap credit to firms through the Credit Guarantee Fund or through public banks – in effect creating “zombie firms.” Other measures include debt restructuring for both companies and consumers, price controls, forcing private banks to keep expanding credit to firms, banning the use of foreign exchange in most contracts, and opening public grocery stalls to control food prices.

Nevertheless, seasonally-adjusted and calendar-adjusted GDP figures of 2018 show the economy stopped in the second quarter and started contracting in the third quarter, even before the currency crunch in August.

The Turkish economy shrank 3% in the third quarter of 2018, as had been anticipatedAnd with 19.7% inflation, Turkey is now officially in stagflation mode.

Pedestrians pass by a foreign exchange office in Istanbul on 9 August as the Turkish lira continues to lose value against major international currencies and inflation skyrockets. Photo: Diego Cupolo/NurPhoto
Pedestrians pass a foreign exchange office in Istanbul on August 9 as the Turkish lira continues to lose value against major international currencies and inflation skyrockets. Photo: AFP/Diego Cupolo/NurPhoto

While Erdogan and his government stubbornly ignore the facts that Turkey’s economy has accumulated structural problems stemming from a debt-led economic growth strategy, and that desperate economic policies have made it worse, citizens are increasingly aware of how serious the situation is. Despite constant public assurances by his son-in-law Albayrak over the health of the economy and the lira, the citizenry have lost faith – as evidenced by their banking habits. 

Turks have been putting more and more of their money into foreign currency accounts in order to safeguard the value of their assets and purchasing power. Dollarization is at its highest level since the 2001 crisis, and more than half of all bank deposits are now held in foreign currency.

Thanks to the contraction of the economy and the decrease in import demand of firms, the current account deficit is shrinking, while demand for foreign currencies has not eased. This is telling of the current fragile state of the economy and the lack of confidence its citizens have in their ruler.

While political analysts suggest that Erdogan’s party could lose its majority in the capital Ankara, and the northwest city of Bursa, elections, economic problems and threats have now become a part of the lives of the citizens. With a 12.3% unemployment rate, 12.3% consumer inflation, 24% food inflation, and a shrinking economy, Sunday’s polls will reveal if Erdogan can maintain his stranglehold on power.