nytimes.com | By Carlotta Gall and Jack Ewing | May 17, 2019

In Turkey, efforts to shore up lira may backfire

ISTANBUL — Even before the Turkish authorities took the extraordinary step of undoing an opposition victory and calling a new election for mayor of Istanbul, the government had spent billions to prop up the country’s flagging currency over the last year and bolster its candidates.

But since last week, as the political turmoil rattles investors, it is spending sometimes a billion a day, even on the sly, to support the currency, the lira, as well as the waning aura of invincibility around President Recep Tayyip Erdogan.

Mr. Erdogan, 18 years in power, was re-elected last year for a new five-year term to a presidency with vastly expanded powers. He has already trimmed civil liberties, purged and jailed political opponents after a failed 2016 coup, and brought a free press to heel.

Increasingly, the president has also taken over management — critics say, mismanagement — of the economy to sustain the nearly unbroken growth that has brought him a loyal following.

For many Turks and foreign investors, the spending to prop up the lira is the latest example of Mr. Erdogan placing his political and personal fortunes ahead of those of his country, this time to regain control of Istanbul, the most important base of his power and prestige.

Even if the government can stave off an economic crisis before the new election, scheduled for June 23, many fear that the profligate spending will increase the likelihood of a collapse that could ripple well beyond Turkey. European banks own billions in Turkish debt.

Last year, the lira lost 30 percent of its value, and it is down 14 percent so far this year.

The loss of the March 31 mayoral election in Istanbul was the most significant sign that support for Mr. Erdogan’s Justice and Development Party, or A.K.P., has become vulnerable as the economy has weakened.

Even before the loss, Mr. Erdogan had used the government budget, the central bank and government-controlled banks to defend the currency, forestall a credit crunch, and even to pay for stands selling subsidized vegetables in the hopes of keeping voters on his side.

But the economic duct tape that the government has used to maintain the support of working-class voters is beginning to come undone, economists say. It looks increasingly unlikely to hold until June 23.

The decision to nullify the Istanbul election — made by a body beholden to Mr. Erdogan, which found that some election officials had been appointed illegally — may ultimately backfire on the president by adding to the economic distress that caused him to lose Istanbul in the first place, analysts say.

“They voted because the economy sucks,” said Atilla Yesilada, an Istanbul-based consultant at Global Source Partners, referring to Turks who switched to the opposition. “And now it sucks even more.”

Among the small businesses that underpin the economy, desperation is already palpable.

Yasin Sahinoglu, who owns two shoe stores in Istanbul’s affluent Etiler and Nisantasi neighborhoods, said that sales had shrunk by half in the days after the election results were thrown out.

That was on top of a 60 percent decline in the previous year, he added. “Everyone is concerned about the future so they prefer to keep the money in their pockets,” Mr. Sahinoglu said.

Durmus Yilmaz, former governor of Turkey’s central bank and co-founder of the opposition IYI Party, said it had been at least 20 years since officials had made a similar attempt to prop up the lira — and it had backfired then.

“Turkey has mortgaged its future,” said Mr. Yilmaz, who spent 32 years at the central bank.

The central bank’s net reserves have been declining since September as the government has sought to bolster the lira. Foreign currency reserves were $74 billion at the end of March, a decline of 5 percent from February, according to central bank figures.

“It seems questionable whether Turkey’s war chest of foreign reserves is strong enough to withstand anything that even vaguely resembles a currency attack,” Bart Hordijk, a market analyst at Monex Europe, a currency trading firm, said in a note to clients last week.

Importantly, since March, analysts say they have found discrepancies in the central bank’s figures on the state of the national reserves, according to Selva Demiralp, an economics professor at Koc University in Istanbul.

Some analysts suspect that the government is discreetly transferring funds to public banks, which are then selling dollars to prop up the lira.

Ugur Gurses, an economic analyst who worked at the central bank in the 1990s, described the government’s action as a “backdoor policy.”

Professor Demiralp said it was unprecedented for the government to hide its actions in this way. The director of the central bank had been asked to explain at a news briefing on April 30, she said, but he could not.

“They want to create the impression that the lira is strong enough,” Professor Demiralp said.

If the central bank runs low on dollars and can no longer prop up the lira on financial markets, Turkey’s economy could face a real collapse.

Oxford Economics, a consultancy in London, ranks Turkey just behind Argentina among countries most likely to suffer a currency crisis.

In a statement on April 30, the central bank said the decline in stocks of foreign currency was temporary, and that the reserves would recover as a cheaper lira made vacations in Turkey and Turkish exports more appealing.

In response to written questions on Tuesday, the central bank showed no signs of backing down from its spending to support the currency.

“The Central Bank will go on using all the means in its hands for the aim of price stability,” the statement said.

It also promised that inflation would fall to 5.4 percent at the end of 2021 from almost 20 percent now.

Yet some signs of economic collapse are already manifest, including rising unemployment, a surge in bad loans and corporate bankruptcies. Perhaps most important is the collapsing confidence of foreign investors, evident in the plunge in the lira.

The China-like growth rates that Mr. Erdogan has delivered until recently would not have been possible without the money from investors attracted by Turkey’s high interest rates.

The sagging lira is a sign that foreign investors are turning away. The impact is felt acutely among Turkish businesses and banks whose debts are valued in dollars, and therefore become harder to pay as the lira falls.

Turkish banks need to roll over as much as $45 billion in loans that must be paid in dollars, Fitch Ratings estimates.

Yet Mr. Erdogan has been seemingly unfazed by the signs of weakness. He was back out campaigning last weekend, riding a vintage red tram along Istanbul’s busiest shopping street and shaking hands with supporters.

It was an unusually low-key approach for the veteran politician, mingling with the people with minimum security, which may have been borrowed from the opposition candidate, Ekrem Imamoglu, who won the most votes in the March election with an all-embracing, grass-roots appeal.

Yet Mr. Erdogan, determined to retain Istanbul under his party’s control, does not otherwise seem ready for change.

Last week Mr. Erdogan promised structural economic reforms, but he has made such promises before. Economists say that his government is tinkering with the symptoms and not addressing the underlying problems.

Those include an overreliance on foreign credit, and too much money spent on construction projects and not enough on schools and universities to produce a more skilled work force.

Even disaffected members of Mr. Erdogan’s party say that the president has moved away from the sound economic management of his early period in government.

“Confidence in the data released in decisions related to the economy is an absolute must,” Ahmet Davutoglu, a former prime minister who was once a close ally of Mr. Erdogan, wrote recently. “Unfortunately, certain recent practices have shaken that confidence.”

Business groups have also become more openly critical.

“We are asking for tighter monetary policy, tighter budgetary policy, a coherent anti-inflation policy,” Bahadir Kaleagasi, the secretary general of Tusiad, Turkey’s leading business association, said in an interview.

As important, he added, were reforms to the rule of law and better relations with Europe. Yet many fear that true change is unlikely as Mr. Erdogan casts out as much economic line as possible to reel in voters in Istanbul.

Just how long the economy will hold together, and what would happen if and when it sours, have now become the most urgent questions before the country.

Mr. Erdogan still controls a formidable patronage machine, and his base of support has endured economic turmoil before.

“Regimes and central banks can always manage a little bit longer,” said Charles Robertson, global chief economist at Renaissance Capital, an investment bank that focuses on emerging markets.

But Mr. Erdogan “is trying to have politics keep primacy over economics and his scope to do that is getting weaker by the day,” Mr. Robertson said. “Those bills still come due.”

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* Carlotta Gall reported from Istanbul, and Jack Ewing from Frankfurt.