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Turkey's lira has fallen to a record low as US sanctions and the effects of an overly politicized monetary policy kick in. President Erdogan's virtual economics may be about to hit a wall of hard truths.
The Turkish lira fell to a rate of 5.1 against the dollar in early Friday trading, breaking the symbolic resistance threshold of 5 for the first time. The currency has lost 4 percent against the dollar over the last week and is down about 36 percent this year, according to FactSet.
The lira plummeted in late July after the Central Bank of the Republic of Turkey (CBRT) left interest rates unchanged as inflation continued to rise, with one analyst likening buying the currency to "catching a falling knife."
The sense of doom was compounded on August 1 when the US imposed selective sanctions on Turkey over the detainment of an American pastor.
"Crucially, the geopolitical risks are now much higher following the decision by the US to impose sanctions on two Turkish ministers. Frankly, we do not know what level of real policy rate would compensate for this increase in risk premium," Inan Demir, an analyst at Nomura, told DW.
Read more: Is Erdogan's Turkey on the edge of a crash?
The yield on the benchmark 10-year government bond was at 18.28 percent at Thursday's close, indicating a big return for those willing to risk financing Turkey's public debt.
Turkey is vulnerable to a stronger US currency because of its large dollar-denominated debt, which becomes more expensive to repay as the lira slips. Emerging economies have been struggling with a stronger dollar, but Turkey and Argentina are highly reliant on foreign — often dollar-denominated — funding, and so when their currencies sell off, it is more expensive to service debt.
Meanwhile, investors left the BIST 100 share index down 2.74 percent on Thursday.
Erdogan's fantasy economics
The currency has been under pressure in recent months amid concerns after President Recep Tayyip Erdogan appointed his son-in-law as combined treasury and finance minister. Berat Albayrak's appointment was taken badly by the markets as a signal that Erdogan would, as he promised, wield more influence in monetary policy.
Erdogan was re-elected in June and thanks to a referendum passed in 2017 he has more power to appoint ministers without congressional approval.
Although Albayrak said after his appointment that the government's "number one goal" was inflation and lower interest rates, few believe it is he who is pulling the strings. He said, for example, he would "not fight the markets," but then rates were held as inflation spiked in July.
"The facts are the June inflation print rose over 300 bps in year-on-year terms, and the CBRT does nothing, so how can a credible central bank suggest that it cares about inflation?" Tim Ash, senior emerging markets strategist at Bluebay Asset Management, told CNBC.
Others describe a "self-feeding circular mechanism that is inflation and currency weakness."
"As the latest MPC decision and quarterly inflation report make clear, the TCMB is not in a position to raise rates and the most that can be expected is to keep rates unchanged for an extended period," Demir said. The CBRT's benchmark rate is its one-week repo rate that currently stands at 17.75 percent.
Inflation not helping
A slightly lower-than-expected rise in headline inflation released on Friday morning figure did little to lift the doldrums.
Inflation rose again in July to almost 16 percent, official statistics showed on Friday. This is its highest since 2004 and far exceeds the central bank's target of 5 percent. Consumer prices increased by 0.55 percent in July, lower than the market consensus of 1 percent, mostly on the back of food prices, which dropped by 0.3 percent on the month.
Read more: Turkish economy facing major challenges
Something's got to give
One analyst, who chose, perhaps indicatively, to remain anonymous, told DW that Turkey's macroeconomic fundamentals have turned more unattractive in recent years.
"The insistence on high growth led to a wider current account, which had already been high relative to Turkey's peers and higher and stickier inflation," she said.
"A rebalancing of the economy is what is needed. Tighter policy mix, primarily on the fiscal front but also on the monetary front, should be implemented. Yet, the political authority has been reluctant to deliver such a mix so far," she went on.
"Given the high level of forex indebtedness of the private sector, a sizable depreciation of the currency increases the odds of a ‘hard landing,' rather than an orderly rebalancing of the economy," the analyst concluded.