Why is the Turkish Lira sliding?

Question

What is the fundamental reason that the Turkish Lira is tumbling down during the last few months?

Kindly, explain in layman's terms and in short.

Answer 1

Besides the general political issues in Turkey, market analysts have pointed out some specific reasons for specific events. A main kicker seems to be Erdogan promising lower interest rates. Back in May.

Investors have hammered the currency - at one point sending it down by as much as 20 percent this year - on concerns about Erdogan’s drive for lower interest rates. The selling accelerated this month after he said he would look to take greater control over monetary policy following June 24 presidential and parliamentary elections.

And in June:

Though President Recep Tayyip Erdogan has rolled back outright claims on how officials should operate monetary policy, investors are proving slow to forget his willingness to encroach on central bank independence.

And now (in August):

Turkey’s lira plummeted as much as 18 percent on Friday as worries about President Tayyip Erdogan’s influence over monetary policy and worsening U.S. relations snowballed into a market panic.

The euro was hurt after the Financial Times reported that the European Central Bank had concerns about banks in Spain, Italy and France and their exposure to Turkey’s woes.

Both currencies added to losses after U.S. President Donald Trump said he had authorized a doubling of tariffs on steel and aluminum imports from Turkey. “Our relations with Turkey are not good at this time!,” Trump said on Twitter.

Also nepotism concerns over the appointment of the new finance minister as well as the loss of a figure connected with Wall Street from the new government, but the immediate shock from that on the lira was smaller (in July):

After news emerged of the appointment of Mr Erdogan's son-in-law, the Turkish lira lost more than 3% of its value. [...]

It has also emerged that Mehmet Simsek, a former banker at Merrill Lynch who acted as deputy prime minister in Turkey's previous government, will not hold a position in the new cabinet.

Oh, and a day later:

Turkey’s President Recep Tayyip Erdogan moved to cement his control over the economy, claiming the exclusive power to appoint central bank rate-setters a day after naming his son-in-law to oversee economic policy.

The moves complete a years-long process that saw members of his investor-friendly A-team removed from the government one-by-one, increasingly rattling markets. The lira plunged on Monday by the most since a failed coup attempt two years ago and is down by 19 percent against the dollar so far this year.

He formalized his increased powers over top appointments at the bank with a decree on Tuesday.[...] The decree, one of the first three after Turkey officially shifted its governance system to an executive presidency, was published in the Official Gazette. It didn’t include any reference to other members of the cabinet in appointing the central bank chief, who used to be named jointly by the president, prime minister and a deputy prime minister in a decree signed off by the entire cabinet.

So basically Erdogan can now appoint the central banker all by himself.

And it turns out there's a substantial Wikipedia article on the topic of this question: "Turkish currency and debt crisis, 2018", which the cause-dedicated sections are "Presidential interference with the central bank" and "Current account deficit and foreign-currency debt" (well, in reverse order) and later "Politics and corruption".

And a more in-depth article on DW in May also pointed out long-term concerns on debt, particularly how it is financed (short-term instruments driving volatiliy):

The key structural reason for the steep fall in the value of the lira is Turkey's excessive external financing need approaching 30 percent of GDP. The bulk of the foreign funds it needs to raise every year arrives in the form of short-term capital flows into the equity, bond or money markets, or in the form of short-term loans.

The reliance on short-term funding makes the lira highly sensitive to sudden changes in global interest rates, in particular US rates, and changes in foreign investor risk appetite. However, the recent lira selloff received additional momentum from more specific factors, namely Turkey's high inflation and the central bank's apparent lack of commitment to bring it down any time soon.

Political pressure on Turkey's central bank to loosen monetary policy had undermined the credibility of the bank. The selloff accelerated significantly when President Erdogan vowed to increase his influence over monetary policy and lower interest rates.

Answer 2

The economic fundamentals of Turkey did not change much from last month to this month. The steel and aluminum industry is significant but hardly vital to the economy. Even if all steel exports to the US were lost, that wouldn't justify the drop in exchange rates we're seeing now.

The exchange rate between currencies reflects the market's faith in the value of the respective currencies, which comes down to faith in the economic strength of the nations and the ease of doing business in the nations.

Either the Lira was overvalued until a few days ago, or it is undervalued today, or both. Faith in a currency can shift faster, and more violently, than the underlying economic strength.

• Simplistic explanations of the market tend to assume that the traders are fully informed and rational. That is not the case, but they are not completely uninformed and irrational, either. Both psychology and hard numbers matter.
• When a currency starts to slide, that can be bad for the economy. This causes the currency to slide even more.
• Speculative traders might sell if the currency drops below psychologically important values, which again causes the value to drop even more.

So (unlike the comment by James K) I believe that what is happening here is mostly a psychological or political effect. The quarrel between the US and Turkey is escalating, that makes traders think that it won't be quite as easy to do business in Turkey as it used to be, that makes the Lira fall.

Answer 3

This article seems to sum up pretty well why the Turkish lira is still falling (in 2020):

The Turkish currency has hit record lows against the euro and US dollar, despite efforts by its central bank to stop the rot. The fall comes as the effects of the global pandemic and poor economic policy converge.

While the pandemic effects are something affected virtually all countries and thus less interesting, the economical policy is worth exploring. This article mentions that the policy affecting how the central bank can operate is an important factor:

The central bank has so far refused to raise its benchmark interest rate. That would be the standard remedy for a falling currency but would conflict with Mr. Erdogan’s unorthodox view that high interest rates cause inflation. The current official rate of 8.25 percent, which the bank left unchanged at its meeting last week, is effectively negative because it is below the pace of inflation.

Another issue is that there is little demand for lira asset and the central bank is running out of dollars and thus unable to compensate the currency decline though buying liras:

The government has pressured banks to lend more, helping to prop up consumer spending but also feeding inflation, which is at an annual rate of almost 12 percent. The declining buying power of the lira is one reason it has been losing value against other currencies. In addition, many foreign investors lost faith in Turkey during the last crisis, in 2018, meaning there is little demand for lira assets.

The central bank has tried to intervene by buying liras in currency markets, but it is running out of dollars to do so, analysts say. Economists say the central bank has begun borrowing dollars deposited in Turkish banks by businesses and residents, a strategy that is likely to end badly.

To sum it up, the main reasons for a falling lira seem to be:

• a poor economic policy that leads little room for the central bank to intervene
• investors losing faith after the 2018 crisis
• the global pandemic