Foreign investors remain cautious over Turkish assets after last week’s plunge in the value of the lira, despite huge intervention to prop up the currency and restore confidence.
The central bank — which had rebuilt the country’s net foreign reserves from deep in the red to about $65bn in the last year — committed more than $25bn in a matter of days, after the lira plunged to a record low beyond 40 to the dollar last week.
The sum, calculated by the Financial Times and referenced by the central bank governor in a call with investors, reflects the high cost of shoring up support for Turkey’s fragile economy in a dramatic week since the detention of Ekrem İmamoğlu, Istanbul’s mayor and the most serious opposition challenger to President Recep Tayyip Erdoğan. The detention triggered the biggest protests in years and hundreds of arrests.
Central bank governor Fatih Karahan and finance minister Mehmet Simsek have helped stabilise Turkish markets amid the exit of foreign capital, with the lira having traded about 38 to the dollar for several days by Thursday.
According to one Turkish official, foreign investors pulled out roughly $16bn, but policymakers believe “the worst may be behind [them]”.
However, foreign investors remain wary that Erdoğan could ultimately fire the duo, who led a turnaround in Turkey’s finances after elections in 2023 to stem a deepening economic crisis. The turmoil this month has reawakened fears of a rush to dollars that the central bank could not hold back.
The hit to reserves to smooth foreign exits is manageable, but “if this kind of heavy intervention does last beyond a week, it will be tough for Turkish policymakers to hold the line”, said Mohammed Elmi, a portfolio manager at Federated Hermes.
This week, Erdoğan blamed Imamoglu’s main opposition CHP for the economic “sabotage” and said he backed the central bank’s actions: “We will never allow the gains we have made from [the economic policy programme] to be harmed.”
In a carefully stage managed call with thousands of investors on Tuesday, Simsek and Karahan said they would do whatever it took to stabilise the lira.
The rebuilding of Turkey’s reserves over the past year and a half was a “remarkable success” for Simsek and Karahan’s policies, said Carlos de Sousa, emerging market debt manager at fund manager Vontobel.
But he also pointed to “how many resources were burned in less than a week that it took a year to accumulate . . . that would be the economic cost of the political decision that was taken.”
A key factor for the currency is a so-called carry trade — borrowing in a lower interest rate currency, such as yen or dollars, to invest in high-yielding assets in another — estimated at $35bn in size by JPMorgan.
Turkish authorities have encouraged the trade as a way of helping fund an economic recovery, with investors drawn in by interest rates as high as 50 per cent.
But as the lira hurtled past key risk limits last week, hedge funds using leverage to juice the trade were among foreign investors rushing to exit, exacerbating the fall in the currency.
“The fuel that led to such a rapid intervention was the carry trade, and much of that carry trade was unwound,” said Brad Setser, senior fellow at the Council on Foreign Relations and a former US Treasury official.
That unwinding should lessen the need for further heavy intervention on the scale of last week, he added. “Turkey could probably go through another $10bn of reserves, but it probably doesn’t want to go through it that fast.”
The central bank’s interventions had restored some level of market confidence, said Yvette Babb, emerging market debt manager at William Blair, but “the thing that they are most concerned about is the potential for locals to start dollarising again”.
Simsek said on Tuesday’s investor call that foreigners had made up about two-thirds of last week’s rush to the exits, compared with local retail investors, who accounted for one-tenth, according to people who took part.
“Tension on the streets is never good for a trade,” said Bradley Wickens, chief investment officer of Broad Reach, an emerging markets hedge fund, which has slightly pared back its Turkey position in recent days.
“The trade could be negatively impacted if democratic governance further deteriorates or if the opposition mounts a material and long lasting campaign with traction as a result of Imamoglu’s arrest,” he added.
Simsek and Karahan did not address the political situation directly in this week’s investor call, said people familiar with its contents.
But investors saw their visibility as itself a sign that Erdoğan is for now serious about keeping them in their posts. This is despite a record of sacking central bank governors, in particular when the going gets tough in Turkey’s economy.
The duo “have been able to pursue what have been market-friendly responses to the volatility”, Babb said. “This very strong response has given the market confidence that their position is protected.”
Investors, however, still faced the “tail risk” that Erdoğan could ultimately abandon orthodox policies, Babb added.
“I do think there was some degree of market complacency, if you can call it that, in the pricing” of that risk, said Babb, whose fund was in the Turkish carry trade but had also bought default protection on the country’s debt.
The risk that Erdoğan, whose unorthodox policies before he appointed Simsek two years ago were blamed for economic turmoil, would add an economic crisis to a political one had “small odds”, said Federated Hermes’ Elmi. But it “would be a real setback in terms of the progress Turkey has made”, he said.
“If he replaced the top economic management team, he really would be staring over the precipice,” he said. Current net reserves levels “would be wholly inadequate, in terms of outflows and the demand from locals to dollarise”.
Additional reporting by Ayla Jean Yackley and Adam Samson