The “Tulip Era” or the “Plucking the Goose Period”

Interesting scenarios are being written in the financial markets. A perception operation is being conducted so effectively that it seems things in Turkey are improving rapidly, and have almost already recovered... It is clear that they are trying to bring Turkey to the state of a “Goose to be Plucked.” 

Let me share what is happening and my predictions piece by piece. Then we can put the pieces together.

The Central Bank announced the policy interest rate as 45 percent. It is clear that there will be no monetary tightening or interest rate hikes until the election. If the policy rate is 45 percent, deposit and bond interest rates will also materialize at the 50 percent level. 

Turkey is in search of a serious amount of hot money, both to keep the wheels of the economy turning and to create a spring-like atmosphere in the economy, even if only for a short time. Although it is not her job, it is said that Central Bank Governor Gaye Erkan held positive meetings with foreign funds during her US trip, and even reached an agreement to a certain point. What kind of agreement could it be? Let's try to figure it out. The expectation of hot money from Turkey was as follows: 

“Raise interest rates. In addition, release the exchange rate that you have been suppressing for two years; allow for some devaluation. Let the rate reach the 36-40 lira level. Then, the risk of a sudden rise in exchange rates in the subsequent period will be eliminated. We will exchange our dollars at 40 lira, buy Turkish Lira bonds issued by the Treasury with interest rates at the 50 percent level, deposit money into time deposits, and enter the stock market. If we exchange our dollars now at the 30 lira level you specify, and the dollar reaches 42-45 lira a year later, the 50 percent interest we earn will be wiped out. We already earn 5 percent from US Treasury bonds.” 

It is a known fact that President Erdoğan will not turn toward cutting spending, budget discipline, and structural reforms in the fight against inflation... Even if he could not stomach it, he approved the interest rate hikes. However, it seems impossible for him to approve a sudden rise in foreign currency, reaching the 40 lira level, especially before the election. It is also clear that increases in the exchange rate trigger inflation in a very short time. Erdoğan is in favor of fighting inflation with the abundant foreign currency at his disposal by making concessions to hot money. However, Turkey does not have sufficient foreign currency earnings; on the contrary, we are constantly running a foreign currency deficit. In this case, the solution that comes to mind is: could it be policies of offering attractive opportunities to hot money, as was the case between 2004 and 2009, to lower the exchange rate and reduce inflation in Turkey with abundant foreign currency? Looking at what is happening, I think they will resort to this path. Without fully escaping the KKM (FX-protected deposit) vortex, we are forced to enter the hot money vortex again. Of course, the price will be heavy.   

After Central Bank Governor Gaye Erkan's return from America, reports from foreign banks and investment fund managers emphasize that Turkey is on the right track and that its credit rating is moving toward investment-grade status. In one investment fund, it was even stated that the Treasury would carry out a bond issuance worth 25 billion dollars. In fact, one of the foreign banks (Wells Fargo) went too far and stated that the dollar, which is currently at the 30 lira level, would decline to 29 lira by the end of the year and to 28 lira by the end of 2025. Local financiers have been a bit more fair, saying that the dollar could reach 40 lira by the end of the one-year maturity. Where they want to get to with this is as follows:

“Forget about the made-up or real inflation in Turkey. We have managed to keep the exchange rate stable for years at the expense of all balances being disrupted. If you invest in Turkey, we will keep the rate at 40 lira again at the end of the year. You will have no currency risk. Therefore, do not expect devaluation; come in at the 30-32 lira level. You will have earned 15 points of interest on the dollar in real terms.”

The government's hope is to create a short-term fake paradise. Just like between 2004 and 2009. During that period, hot money flowed into Turkey due to high real interest rates on one hand, and record levels of direct foreign capital inflows occurred due to full membership negotiations with the EU on the other; the Turkish Lira gained value due to the effect of abundant foreign currency, imports exploded thanks to cheap foreign currency, goods became abundant in the market, and inflation fell. During that period, hot money took about 2 percent of Turkey's National Income as interest every year and left. However, the remaining impact was much heavier than the billions of dollars it exploited and took away. 

The lasting heavy impact can be summarized as follows: Due to the Turkish Lira being more valuable than it should have been, the farmer could not cope with imported agricultural products and gave up production; the industrialist gave up on intermediate input industries in particular and turned to imports and construction; Turkey entered a major debt trap. Turkey could not get rid of the diseases of lack of production, consuming more than it produces, dependence on imports, and running a foreign deficit that it entered during that period. It is struggling in the debt trap it has fallen into. The deterioration in income distribution and misery continue to increase.

It is clear that foreign bankers seem convinced, at least for the period until the elections. Great concessions will be made to hot money, and the exchange rate will be tried to be controlled as it has been for the last two years. After a while, the hot money will take its honeyed interest and leave, and the foreign debt dependency level of Turkey, which does not produce and cannot produce, will become more frequent like the increasing seizures of drug addicts. As in the 2004-2009 period, in other words, a “Tulip Era” for the AKP and a “Plucking the Goose Period” for foreigners will begin. Wealth will be transferred from domestic to abroad. 

WILL THIS SCENARIO WORK, WHAT WILL THE LOCALS DO?

I deduce these from the reports of foreigners. But the fundamental question is: To what extent will the locals trust this scenario, which is created by masking the realities of the economy and creating a perception that “things are improving” in the money markets? More important than the money coming from outside is the foreign currency in the hands of the locals... The government is already after this foreign currency... Will the locals sell their foreign currency and gold and turn to Turkish Lira instruments? 

If we were to write about the “Sucker Shaking” operations that local investors have faced in previous years, it would fill volumes of books. Dollars exchanged at 2.5-3 lira while dancing halay... Dollars bought at 18 lira believing the statement that interest rates would fall further, and the dollar that was dropped to 13 lira with the indirect interest payment KKM invented in the middle of the night... Central Bank back-door sales... And I have no idea about the possibility of savers, who have been hurt by many similar operations, exchanging their foreign currency and gold after all this experience. Because we have witnessed many times that promises made in the past and not kept are forgotten at the ballot box.  

I don't know about the behavior of the locals, but it is worth looking at a few data points that weaken the probability of this scenario working. Today's Turkey is not the same as the Turkey of 2004. At that time, not only hot money but also a large amount of direct foreign capital was coming due to the start of full membership negotiations with the EU. Currently, Turkey has broken away from the EU. Due to major problems that have emerged such as the legal system and judicial independence, it is also about to be expelled from the Council of Europe, of which it is a founder. At that time, the AKP had taken over 29 percent inflation and reduced inflation to 8 percent thanks to abundant foreign currency. But today, TURKSTAT's made-up inflation is 64 percent, and the real inflation is 129 percent... Back then, the external debt was 131 billion dollars; today it is 482 billion dollars. While the current account deficit was three per thousand of the national income, today it is 20 times that, at 6 percent. We can add many more data points. In addition to the few indicators above, let's look at the budget and the situation of the Central Bank. It has deemed monetary tightening sufficient. It announced the inflation target as 36 percent. So how compatible is the 2024 budget with these targets:

The 2024 budget is increasing by 81 percent compared to 2023. It will rise from 6 trillion 585 billion lira to 11 trillion 911 billion lira. The budget deficit is increasing twofold compared to the previous year; it will rise from 1 trillion 374 billion to 2 trillion 600 billion lira. Interest payments will double, rising from 675 billion lira to 1 trillion 254 billion.   

Let's also look at the Central Bank. Net reserves are at minus 51 billion dollars. And the size of the KKM, one of the biggest black holes in history that is not in the account and that they are trying to make us forget, is at the 90 billion dollar level. Even if the dollar only increases by 10 lira as the most optimistic expect, the burden of KKM on the Central Bank will be 900 billion lira, which is not included in any equation discussed so far. Under these conditions, how can the Central Bank implement a monetary tightening policy? Who knows what will happen after the election? 

In light of all this data, TURKSTAT can announce its made-up 65 percent inflation as 36-40 percent. It is not a problem for TURKSTAT. But do you think the real inflation, which is 129 percent, will fall by the end of the year? I had announced my inflation forecast for the end of 2024 as 140-150 percent for now, provided that I revise it again in May. 

In a period where a controlled exchange rate guarantee is provided, foreigners may come for a 30-35 percent exchange rate increase and 50 percent interest for a short period. As long as a guarantee is provided for the exchange rate, inflation in Turkey does not matter to foreigners. But can we say the same for local investors? While foreigners take the dollars they brought with Central Bank back-door sales at a low level and leave, can locals find the opportunity to buy back the dollars they exchanged at the same rate? If inflation, which is not important for foreigners, is not 36 percent but 140 percent in reality in 2024, how happy will 50 percent interest make the locals who exchanged their gold and foreign currency?