After taking a shellacking from markets stunned by Turkish President Recep Tayyip Erdogan’s comments on his perceived role in monetary policy, the Turkish lira (TRY) recovered some ground on May 16 after the central bank said it was monitoring the situation and would take necessary steps.

The TRY descended to an unprecedented 4.5011 to the dollar by around midday local time before trimming losses. It stood at 4.4215 by 18:25 as investors sought any sign they could get that the Central Bank of the Republic of Turkey (CBRT) has not been reduced to an Erdogan stooge and is moving closer to action to stem the dumping of the currency.

In a statement on its website, the CBRT said it “is closely monitoring the unhealthy price formations in the markets. Necessary steps will be taken, also considering the impact of these developments on the inflation outlook”.

Meanwhile, Mehmet Simsek, the deputy PM who heads the government’s economic team, wrote on Twitter: “I still hope & believe that political pragmatism will ultimately prevail. A rule based market economy is the only viable option going forward. Therefore, we remain committed to a sound & prudent policy framework. The policy mix is much more likely to improve post [June 24] elections.”

The TRY began its latest worrying decline after on May 15 Erdogan—who regularly calls for cheaper lending amid Turkey’s overheating economy despite conventional economic theory stating that the precise opposite is needed—told Bloomberg TV in London that he planned to tighten his grip on the economy and assume a greater role in setting monetary policy if he is kept in power by the upcoming snap election.

Circuit breaker
His comments left investors and analysts flabbergasted and the market is now clearly looking for a circuit breaker from the CBRT, namely substantial tightening that halts the decline of the lira, down around 15% against the dollar in the year to date. Investors in Turkey “need plain vanilla central banking and not some big Erdoganite economic experiment based on little/weak economic foundations”, BlueBay Asset Management strategist Timothy Ash said in a note on May 5.

The TRY has been one of the currencies hardest hit by an emerging-market selloff this year amid anxieties that Turkey’s interest rates are too low given its surging current-account deficit—at 6.5% of GDP one of the widest in the world—and sticky double-digit inflation, as well as worsening inflation expectations. Some investors are calling for a sharp interest rate hike of 200 basis points to restore market confidence, perhaps at an emergency meeting.

“Now we just have to see whether ‘necessary’ is the same to the central bank as it is to the market,” Henrik Gullberg, a strategist at Nomura International told Bloomberg. “The market needs a circuit breaker, that circuit breaker can only be a prohibitively aggressive rate hike.”

The deteriorating set of domestic and international economic negatives faced by Ankara has also forced up the yield on Turkey’s 10-year government debt, which has climbed above 7%, up from 5.2% in January.

On May 15, Reuters reported that fund managers who met Erdogan and his delegation in London on the last day of his three-day visit to Britain were baffled about how he plans to tame rising inflation and a currency in freefall—while simultaneously seeking lower interest rates.

Some said that while Erdogan has crushed his domestic enemies, he would find taking on international financial markets with policies that defy economic orthodoxy much tougher.

“He picks battles with everybody... he is fighting the opposition, he is fighting [self-exiled preacher and alleged attempted coup plotter Fethullah] Gulen, he is fighting the extremists, he is fighting after the failed coup—now he is fighting the markets, and that is dangerous,” one fund manager at a major asset management firm, who preferred to remain anonymous, told the news agency. “You can find your domestic foes all you want, but when you are trying to take on a financial market, that is a battle you can’t really win,” said the manager, whose firm attended a closed-door investor meeting with Simsek.

“Why the hell would you come to London, and basically send this message to institutional investors which is exactly what they did not want to hear?” another investor reportedly said.

Loaded up on FX-debt
Turkey, loaded up on hard-currency debt, is badly exposed by the severe devaluation of the TRY. The country’s overall stock of private sector debt has jumped from 33% of GDP in 2007 to 70% today, a build-up comparable to that seen in Greece before its financial crisis in 2009, according to investment bank Renaissance Capital. Indeed, in 2017 Turkey saw the most extensive increase in its financial sector debt-to-GDP ratio of 39 developed and emerging countries tracked by the Institute of International Finance (IIF).

Turkish banks’ foreign currency-denominated debt, mostly in dollars, stands at 22.5% of GDP, a ratio only behind those of Singapore, Hong Kong and South Korea among 21 major EMs in the IIF’s database.

Hung Tran, executive director of the IIF, was reported by the Financial Times on May 14 as estimating that Turkey needs to attract foreign capital equivalent to 25% of its GDP every year in order to cover both its large current account deficit and the amortisation of its existing debt.