The Turkish Lira is plunging despite high growth. Why?

Turkey had a record growth rate of 7.4 percent in 2017. But as of April the Turkish Lira has depreciated by 8 percent in 2018. This trend, it seems, will continue. Can we say that record growth has made the lira more vulnerable? If so, why?

Let me start with the salient characteristics of the Turkish economy. The country has always suffered from a low savings rate. Turkey has always had a current account deficit. As it does not have enough resources to fund its growth, it has always borrowed from foreigners. That is just how the country is built. So if Turkey grows at an exorbitant rate, it needs to borrow more. That means a 7.4 percent growth rate inevitably has consequences.

But this by itself could not be a reason for the lira’s depreciation. It is not about speeding up growth per se, but rather speeding up in the present global and regional environment with current economic policies. That is what makes the difference. Let me try to define what I have in mind.

First, the global environment. Financial markets have moved from quantitative easing (QE) to quantitative tightening (QT). That is a hell of a change. “QE is a period of too much money chasing too few bonds while QT is just the opposite,” a recent Bank of America analysis stated. Scarcer money chasing many more bonds means more competition for funds. That means higher interest rates and higher funding costs. This is not good for a country that needs to borrow to grow. Borrowing always means being more vulnerable. By definition, the need to borrow more now makes your country more vulnerable. That is one way global developments are hastening the depreciation of the lira.

Second, regional dynamics are rapidly changing. The Syrian civil war continues to weigh Turkey down. It has derailed the Kurdish reconciliation process and brought back Ankara’s existential fears. Now that the winners and losers have become more visible on the ground, the war will enter a new stage in which a new constitution will be written. Turkey has so far acted together with Russia and Iran out of practical reasons, but it has a different vision of the endgame than those countries. Turkey’s traditional allies in the West lack a clear-cut Syria strategy, and even if they did it would be likely to conflict with Ankara’s interests. So it looks like Turkey is going to go through a tough time geopolitically.

In this new global setting, the West is likely going to take a tougher stance against the revisionist powers of Russia and Iran. Taking one quick look at the people around U.S. President Donald Trump, it is entirely conceivable that Turkey might also be put into that basket of countries. The prospect of that kind of friendly fire won’t do any good for the lira.

Third, Turkey lacks a smart game plan (to put it mildly). Ankara is focused on the 2019 elections and very few people are thinking seriously about the changing ecosystem we are in. Domestic monetary easing in an era of global tightening is not a smart decision, but it appears inevitable.

What is currently happening and what is about to happen is not even interesting economics. It is basic and obvious. It is like the story of a murder foretold. Like the case of former Prime Minister Tansu Çiller in April 1994. That year, the lira depreciated 50 percent after the Treasury cancelled T-Bill auctions and left all those liras in the market with no instrument to mop up the liquidity. It was a rather boring tale in terms of economics, but it was fascinating for anyone interested in the way institutions work in nascent democracies.

Shortly after the 1994 crisis, someone on a panel in Washington said the following: “Why bother to write anything on this? It is like asking what will happen to a pressure cooker if you leave it on the oven too long. You don’t need a degree in chemistry to know that the thing is going to explode.” You really don’t.