Turkey took its boldest steps yet to try to ward off a financial crisis by making it harder for traders to bet against the battered lira and easing rules on restructuring troubled loans that have already topped $20 billion.
As President Recep Tayyip Erdogan intensified a diplomatic feud with his U.S. counterpart Donald Trump with a spate of new import tariffs, the nation’s banking regulator published new rules that have so far succeeded at lifting the lira off record lows. Investors continued to demand higher interest rates.
The measures “are aimed at the symptoms of recent lira weakness and not the cause,” said Nigel Rendell, an analyst at Medley Global Advisors LLC in London. “The cure for a persistently weak currency is not rocket science, nor is it liquidity measures and policy tweaks – it is higher interest rates.”
Erdogan, who tightened his grip on power in June elections, is refusing to give in to pressure from Trump to release an evangelical pastor who he accuses of aiding a coup attempt against him two years ago. A court on Wednesday rejected an appeal for the release of Andrew Brunson from house arrest.
The standoff between the two NATO allies has escalated quickly since Trump slapped sanctions on the interior and justice ministers on 1 August, following that move with tariffs on Turkish steel and aluminum imports last week.
Tit for Tat
In retaliation on Wednesday, Turkey said it was imposing taxes of ranging from 50 to 140% on rice, alcohol and cars from the U.S. That comes after Erdogan called on Turks to boycott American electronics, like the iPhone, which have in any case become a lot more expensive as the lira lost almost 40 percent of its value this year. The collapse, which intensified this month and triggered contagion that spread across emerging markets, is making it much more costly for businesses to refinance at least $16 billion in bonds denominated in foreign currencies that are due by year-end, according to calculations by Bloomberg.
Businesses that earn revenues in lira and have dollar loans are also struggling. While officially the bad debt ratio at Turkey’s banks is just 3 percent, lenders are in the process of renegotiating upwards of $20 billion of loans to try to prevent them from going into default.
Against this backdrop, the nation’s banking regulator issued back-to-back statements starting late on Tuesday to try to ward off a crisis. The steps spurred a 3% gain in the lira to 6.1648 per dollar by 1:56 p.m. in Istanbul, after an 8.4% advance on Tuesday. The recovery also spilled into the bond market, with yields on 10-year local debt falling 28 basis points to 21.1%.
The regulator gave banks more flexibility in dealing with Turkish companies and individuals who aren’t able to make debt payments. Banks can extend the maturities, refinance loans, extend new debt to help troubled companies, and seek new collateral. They can also demand debtors sell assets to repay loans. Overdue loans can now be restructured within two years from the day a framework agreement is signed.
In another unconventional step, the regulator said that until markets “normalise,” it would temporarily stop applying the effect of day-to-day losses on the securities held by banks to their capital adequacy ratios.
Then on Wednesday, it limited the amount of currency swap transactions banks can participate in by half to 25% of shareholder equity, after imposing a 50 percent limit on Monday from none earlier. What this does is prevent investors, like hedge funds, from accessing lira liquidity in the offshore swap market. This drives up short-term borrowing costs and makes it less appealing to borrow liras from local lenders to bet against, or short, it.
The lira is still down 20 percent in August and many investors will wait for steep interest rate hikes from the central bank before they return, especially with inflation at a 15-year high of almost 16 percent and climbing. On Tuesday, Turkish companies and banks joined the call for higher interest rates to stabilize the situation. “This is the usual smoke and mirrors. It can buy time, finger in the dike, but the longer term issues remain,” said Tim Ash, a senior emerging market strategist at Bluebay Asset Management LLC in London.
While policy makers have hiked lending rates by 500 basis points this year to 17.75 percent, they’re under constant pressure from Erdogan to keep rates low because he thinks it’s better for the economy. Before winning near-absolute power in June, he pledged to meddle more in monetary policy.
With the diplomatic spat with the U.S. showing no signs of letting up, Erdogan will be speaking with German Chancellor Angela Merkel on Wednesday and French President Emmanuel Macron Thursday, his spokesman Ibrahim Kalin said in Ankara.
According to Bloomberg calculations, Turkey’s new tariffs affect goods that accounted for $1 billion of imports last year, similar to the value of the metals subjected to higher U.S. taxes. The decision shows Turkey giving a proportionate response to American “attacks” on the Turkish economy, Vice President Fuat Oktay said in a tweet.