Turkey, you might say, has more or less been in limbo since election night on March 31. The economy, the financial markets, domestic and foreign politics—in short, the country as a whole—are all waiting to find out what road the previously invincible President Recep Tayyip Erdogan will take following poll results showing that he and his AKP party have lost Ankara and Istanbul to the opposition.

Might the election board risk derision by coming up with less than rock solid claims of voting irregularities to overturn the ruling party’s unprecedented defeats in the two cities? If it does so there are those who will declare that democracy is dead in Turkey, but until the Erdogan administration decides which way to go at this crossroads, all the country can do is wait.

Banks pushed into swaps
On the market frontlines, meanwhile, the central bank’s regular weekly bulletins published on April 4 have provided some insights on what is going on with its reserves. The national lender has basically been pushing local lenders into Turkish lira (TRY) against dollar swaps with a one-week maturity after it scrapped its one-week repo auctions on March 25, the first day of the latest market turmoil to engulf the Turkish economy.

Since that day, the central bank has gradually increased the lira swap sale limit for local lenders to 40% from 10% for transactions that have not matured. The regulator obviously needs more FX. Rumours are still flaring that it is short of what it requires because of instances in which it has channelled FX sales through public lenders and other state-run enterprises. Its main line is that it has made standard FX sales to energy importers, but the figures don’t add up.

The central bank’s net international reserves rose to $29.7bn as of March 29 from $26.1bn as of March 22, according to Reuters’ calculations.

“So locals still dollarizing, and portfolio data shows USD1.3bn in sales for the week, and then CBRT [Central Bank of Republic of Turkey] saw net reserves rise....something weird here,” Timothy Ash of Bluebay Asset Management said on April 4 in an emailed note to investors.

There are no clear explanations for how it is that the central bank’s reserves rose last week while the lira was being suppressed to prevent a sharp depreciation in the days prior to the local elections. The most logical explanation seems to be that the rise was thanks to temporary funds obtained from local lenders via swap transactions while the lenders’ lira swap sale limits reached 40%.

‘Ponzi scheme’
The central bank's ‘Ponzi scheme’ does not seem that promising as the mathematical limit on hiking the swap limits stands at 100%.

After March 25, the central bank’s weighted average cost of funding gradually reached 25.5% from the current policy rate of 24% at the one-week repo window. It has stayed there this week. The regulator imposes interest of 25.5% on the lira it provides to local lenders at the swap window while it pays 2.25% on the lenders’ dollars. It also provides direct liquidity to local lenders through the overnight lending window at the same interest rate of 25.5%.

“We expect the CBRT to resume its funding through the one-week repo rate at 24% ahead of its April 25 MPC meeting. However, if this would not be the case, the MPC would raise the one-week repo rate to 25.5%. The course of the TRY in the coming period will be influential at this point,” Ozlem Bayraktar Goksen of Tacirler Invest said on April 3 in a research note on the March inflation data release.

The central bank’s weekly bulletin also showed that locals’ total FX deposits at local lenders rose further by $2.65bn to $181.9bn as of March 29. Residents’ FX deposits ex-gold rose $2.4bn, according to Bloomberg’s calculations.

Individuals’ FX deposits rose by $2.23bn to a fresh record of $109.3bn while legal persons’ FX deposits rose by $418mn to $72.7bn.

Non-resident real persons relentlessly increased their FX deposits for 25 consecutive weeks from October 5.

Reports from Reuters have suggested that locals started selling FX this week, but there is as yet no tangible evidence.

Also on April 5, the customs ministry released initial data on foreign trade in March. It showed that the foreign trade deficit continued to contract, at a clip of 68% y/y in March to $1.97bn, while the contraction in Q1 was recorded at 72% y/y, producing a figure of $5.95bn.

Despite liquidity easing in fiscal expenditures and public banks’ lending, it seems the shrinkage in the foreign trade deficit, and as a result in the current account deficit, was sustained in the first quarter. However, it should be noted that even as recession-dogged Turkey’s economy contracts, it is still carrying an annual current account deficit. Even with economic activity remaining somewhere near the bottom, taking into account upcoming external debt roll-overs, the FX-credit-fuelled country’s external borrowing requirement for 2019 remains close to $200bn.

Screw tightening
Jitters over the economic fundamentals are naturally not helped with the screw tightening on the Erdogan administration in both domestic and international politics. At home, Erdogan is still counting those darned untidy votes in Istanbul, while over in the US, where western powers have been celebrating the 70th anniversary of Nato, there is plenty of indignation that Ankara has somewhat spoilt the self-congratulatory atmosphere by pushing its refusal to back down from buying Russia’s S-400 missile defence hardware to the point where on April 3 US Vice President Mike Pence had to step in to declare:: “Turkey must choose. Does it want to remain a critical partner in the most successful military alliance in history or does it want to risk the security of that partnership by making such reckless decisions that undermine our alliance?”

Next up is Donald Trump with his considered thoughts on the matter. Perhaps Erdogan’s best hope is that the Commander-in-Chief will venture that there’s nothing wrong with cutting a bargain deal with Uncle Vlad.

On April 8, Erdogan will indeed be in Moscow to meet with Vladimir Putin while the Turkish finance minister, Erdogan’s son-in law Berat Albayrak, is expected on the same day to deliver a PowerPoint presentation designed to offer markets encouragement that real, post-election economic reforms are on the way (if he can achieve a semblance of hope that may have to do) before he travels to Washington on April 12 for a week of meetings, including encounters with IMF officials.

Piotr Matys at Rabobank was on April 4 quoted by the Financial Times as observing: “A PowerPoint presentation with slides claiming that the economy is rebalancing quickly and a few bullet points may not prove sufficient to restore confidence among investors after Turkey used drastic measures ahead of the elections to keep the lira stable.

“The market expects concrete measures to address economic imbalances accompanied by a specific timetable. Ideally, structural reforms should be overseen by the IMF, but one has to be realistic that it is very unlikely that Mr Albayrak will visit Ms Lagarde in the near future.”

If past experience holds, Erdogan will pull new rabbits from his now 17-year-old hat (it is that long since he rose to the top of Turkish politics after finding prominence as mayor of his home town, Istanbul) that will calm down all the stakeholders in his government. Or maybe he will eliminate some of them and cut deals with new ones as he attempts to reassert an unbending grip on power. But that would mean making new enemies in close environs and raising the pressure level domestically.

Turkey again finds itself dicing with a potential cliff-edge. But it has been here so many times before in decades past. Not that the strongman shouldn’t be worried. His field of play is narrowing all the time.