Turkish economy facing many challenges, says Cypriot economist

The Turkish economy is in a difficult situation, with record levels of foreign currency sales to support the Turkish lira, which no longer accurately reflects the economy, according to professor of finance at the University of Cyprus Andreas Milidonis.

When asked to comment on the state of the Turkish economy by the Cyprus News Agency (CNA), Milidonis noted that the powers currently held by the Turkish President allow him to move in any direction on economic matters without significant institutional control from the opposition.

Milidonis issued a reminder that until early 2022, the performance of the Turkish lira hinted at a positive image of the Turkish economy.

However, since then, the country has implemented a programme of guaranteed deposits, announced in December 2021, transferring a large portion of the exchange rate risk to public finances.

Additionally, he explained, Turkey has experienced increased inflows of foreign currency from countries such as Russia and Gulf states, but has also entered into loan agreements with China, bolstering the foreign exchange reserves of the Central Bank.

This, he noted, covers Turkey’s short-term needs, as it allowed the support of the lira until last Friday, but it is expected to continue for a little while longer.

“The transfer of a significant part of the exchange rate risk to public finances through the deposit guarantee programme is evident from the risk premiums of Turkey’s government debt immediately after the end of 2021,” Milidonis noted.

“The risk premiums decreased when polls showed a possible victory for the opposition, but they skyrocketed after the first round of the presidential elections, where the increased chances of Recep Tayyip Erdogan’s re-election became apparent,” he added.

Milidonis also mentioned that the Central Bank of Turkey has intervened by selling foreign currency in favour of the lira, especially over the past two months, reaching record levels of intervention.

The professor identified two risks stemming from this situation. The first one is that the countries currently supporting Turkey’s short-term financial needs may not extend their trust in the Turkish economy by not renewing their contracts, such as swaps and deposits, among others.

“As you can understand, this risk is determined more by political rather than economic developments,” he said.

The second risk, he continued, is that foreign currency depositors in Turkish banks may request their money back.

“This does not seem likely at the moment, as there have been no indications so far of a foreign currency outflow. This risk could be addressed through capital controls if implemented,” he explained.

“Having a glance at international markets, as well as the statements made by large investment funds, mainly from Western countries, there appears to be hesitation from Western countries to invest in or finance Turkey’s short-term needs due to an unorthodox monetary policy that they do not find attractive,” he added.

Given the achievement of his reelection goal, Milidonis stated that Erdogan is not called upon to make corrections to the economy.

The professor further clarified his point by saying that, for example, “large foreign currency sales from Turkish banks to support the current exchange rate of 20 Turkish lira to 1 dollar that we see today cannot continue.”

“The markets at the moment expect a depreciation of the lira above 20, with some estimates exceeding 24 lira to 1 dollar,” he added.

Such depreciation would have significant fiscal costs, as the state would have to absorb this damage for all the deposits currently in the guaranteed deposit program, which account for about one-quarter of total deposits in the Turkish banking system.

Asked about inflation, the professor said that it is close to 50 per cent, according to the Statistical Institute of Turkey, while interest rates as determined by the Central Bank are below 10 per cent, in single digits.

This means that the cost of living for the average citizen is rising significantly, and the purchasing power of their money is decreasing, he noted, stating that this cannot continue for a prolonged period of time.

“Either there will be a correction of the lira from abroad because the Central Bank will not be able to maintain the exchange rate where it wants, or it will be forced internally to reverse monetary policy issues,” he stated.

“This means increasing interest rates to control inflation. A similar reversal occurred in the autumn of 2020 with the dismissal of the then Governor of the Central Bank and the subsequent increase in interest rates,” he added.

The coming months, he said, are expected to bring significant foreign exchange inflows from tourism, which may prolong support for the lira if needed, but once again, he noted, this practice is not sustainable.