By Marc Jones

LONDON (Reuters – Although a big drop in currency isn’t unusual these days, its precipitous 20% plunge during the week has increased the risks of a crisis of balance of payments unless authorities act quickly.

The Lira plunged 15% on Tuesday. This was the biggest daily decline since 2018. Analysts worry that further falls could follow.

The bottom line is that President Tayyip Erdogan has pressured the Central Bank of Turkey to reduce interest rates, even though inflation could be as high at 20% or higher, and economists warn that this can lead to a collapse in the currency.

After years of failing FX interventions, currency reserves now stand at $30 billion deficit. This is compared with $30 billion positive in 2018, which was $30 billion. If Turks start withdrawing money, it could lead to worsening conditions.

Societe Generale (OTC)’s Phoenixkalen spoke out about how the current lira-rout can be stopped. Capital controls and a series emergency rate increases are possible in light of the depletion of FX reserves.

Erdogan is now more vocal in his rejection of high interest rates. He said that policies which would “condemn people to unemployment and hunger, poverty” are unacceptable. However, most Turkey veteran watchers believe rate hikes must occur.

Goldman Sachs (NYSE 🙂 anticipates that the 15% rate will rise to 20% by mid-2019. This is despite the fact that the traditional economic rules and models show that 26% rates would be needed in order to get inflation to the central bank’s target of 5%.

Analysts at Goldman Sachs acknowledged that “Considering the fact that elections are just 18 months away we believe that such an option would be unlikely.”

Ahmet Davutoglu – a former prime Minister, who worked alongside Erdogan – warns the lira collapse could cause a crisis in the balance of payments. A situation where a country doesn’t have the funds or ability to borrow the money it needs to purchase essentials.

Credit rating agency S&P Global (NYSE:) last month estimated that over the next 12 months close to $170 billion of mainly dollar-denominated foreign currency debt needs to be refinanced – the equivalent to 23% of GDP and far more than reserves could cover.

Woes can quickly spiral if the lira slump renders this task impossible or difficult.

Turkey had faced such problems in the past. It needed IMF rescue in 1999. Davutoglu said that Turkey’s current debt of $3 trillion was due to dollars. This crisis added another $236 billion ($236 million) to Turkey’s total debt.

On Tuesday, he stated that “the picture we are facing right now will lead to a balance-of-payments crisis comparable to the one of the 1970s.”

Erdogan stated this week that Turkey’s budget and banking sectors are both strong. Erdogan also said the government doesn’t have any immediate funding needs to invest.

Erdogan declared, “We understand very well what this policy is about, why we are doing that, what risks we face, and what results we will get at the end.”

RISEING COSTS

Other people believe that a BoP crisis doesn’t yet exist.

The Institute of International Finance has estimated that this year’s current balance deficit will be $15 billion. That is 2.1% of the GDP. It was $22 billion (or 2.8%) back in 2018.

Manik Narain, UBS’ Head of EM Strategy at UBS believes that Turkey has a low debt ratio (less than 40%) which means it can afford to bail out banks and large firms if necessary.

Bank for International Settlements data however shows that the nearly 90% drop in the value of the lira in the past decade has caused severe damage.

The private sector used 7.4% to pay interest on loans in 2011, back when it was just 7.4%. This was 19% at Q1 2012, before the collapse of the lira by another 30%. A little over 55% of Turkish bank deposit are in dollars now, according to Turkish central banks data.

Narain reminds us that the market is not always as confident as it should be. While things may look good, a country could easily finance a deficit between 3-4% and 3%. However, if capital is running away it can prove expensive and challenging.

He said, “It is the same old problem we’ve been seeing for a long time.” “We need the central banks pushing back, giving the market an orthodox policy, and a credible commitment towards positive real rates,” this refers to interest rates when inflation is taken into account.

Yvettebabb, William Blair fund manager, is also against the notion of a BoP crises. Babb says the lira’s slump will further decrease imports, and that although rising energy costs may weigh on exporters, they should still benefit from tourism.

She stated that Turkey’s ability “to continue to rollover its external debt” will be crucial.