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Pressure on Turkey's Economy Builds as Lira Heads to Record Low

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05/06/2020 | 09:15am EDT

By Caitlin Ostroff and David Gauthier-Villars

The Turkish lira slid to its lowest level in two years Wednesday as investors speculated that its central bank would struggle to stem the currency's decline amid the coronavirus economic crunch.

The lira dropped 1.1% against the dollar, with one dollar buying 7.15 Turkish lira, which would be its lowest closing level ever, after falling by nearly a fifth this year. The lira briefly traded at a weaker level on an intraday basis during Turkey's August 2018 currency panic.

Turkey entered the coronavirus economic crisis already in weak financial shape, with high inflation and anemic growth. Its tourism sector, a key part of the economy, faces a major downturn. And much of its biggest export market, the European Union, is under lockdown.

Faced with dwindling foreign-currency reserves, Turkey has held talks with U.S. officials to see if the Turkish central bank could gain access to dollar swap lines rolled out by the Federal Reserve, according to a senior Turkish official and a top U.S. diplomat.

Turkey wasn't among the countries, such as Mexico, Brazil and Norway, that the Federal Reserve offered dollar lending swap-line agreements to in March.

Turkey drew down more than $19 billion from foreign-exchange reserves in March, buying the lira to cap its decline against the dollar. This brought total reserves to around $56 billion, but the true number may be much lower.

Much of those reserve funds likely come from the central bank borrowing dollars from domestic banks, which means the central bank owes more foreign currency to them than it has in its coffers, according to Brad Setser, a senior fellow at New York-based Council on Foreign Relations.

A falling currency and depleted reserves will heap pressure on Turkish banks, which have almost $79 billion of short-term foreign-currency debt due by February 2021, according to data from Turkey's central bank.

"It seems as if the confidence in the central bank is disappearing pretty quickly," said Per Hammarlund, chief emerging-market strategist at SEB Markets. "We know the central bank is running out of money. They are bleeding reserves."

Following a sharp selloff in the lira in the summer of 2018, the Turkish central bank stabilized the national currency by sharply raising its benchmark interest rate. But under pressure from Turkish President Recep Tayyip Erdogan, who said the priority was to boost loan distribution in the pursuit of strong economic growth, the central bank slashed its lending rate to 8.75% from 24% over the past 10 months, leaving the lira exposed to investor sentiment.

"For Turkey in particular, high inflation has been a huge problem and that's one of the reasons the currency has been so heavily controlled," said Viraj Patel, a foreign-exchange and global-rates strategist at research firm Arkera.

The usual port of call for countries facing difficulties with their national currencies is the International Monetary Fund. But Mr. Erdogan has repeatedly ruled out turning to the Washington-based institution. Members of his administration have explained that it would be a sign of weakness, which would risk undermining the 66-year-old president's political standing at home.

Analysts said the U.S. would be loath to extend swap-line assistance to Turkey, in part because of unresolved tensions born out of Ankara's decision to procure S-400 air-defense systems from Russia.

"The political landscape might change," said Haluk Burumcekci, an economist and financial consultant based in Istanbul. "But I don't expect the Fed will help Turkey because of the S-400 issue and because of a lack of transparency on the part of the central bank over foreign-currency reserves."

In a recent online briefing organized by the Atlantic Council think tank, U.S. Ambassador to Turkey David Satterfield confirmed that Ankara had been in contact with the Federal Reserve, and said issuing swap line was a financial, not a political question.

"There are certain requirements set by the open markets committee of the Fed with respect to potential eligibility," the ambassador said. "They are financial monetary requirements, and conditions that are not politically linked."

A Fed spokesman didn't immediately respond to a request for comment.

Facing similar problems last year, Ankara sought help from Qatar and China, which lent $5 billion and $1 billion through swap lines to Turkey, respectively.

One silver lining for Turkey this year: The collapse in oil prices and diminished energy bills have reduced some of Turkey's immediate needs for foreign currencies.

Write to Caitlin Ostroff at caitlin.ostroff@wsj.com and David Gauthier-Villars at David.Gauthier-Villars@wsj.com


Corrections & Amplifications

This article was corrected at 1458 GMT because the original misspelled Haluk Burumcekci's first name as Hakul Burumcekci.

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