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

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


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.

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  • That Economist article actually shows it's most often negative. The first sentence: "A devaluation is a cut in a nation’s standard of living. Unless the exchange rate is clearly out of line with fundamentals, it’s not a good thing". Indeed, all imports get more expensive (more costly to buy stuff) whereas exports get more competitive (easier to sell stuff to other countries). – JJ for Transparency and Monica Aug 11 '18 at 18:06
  • @JJJ: The "unless" part hides a lot of complexity. It might not have been the best choice of link for that topic, e.g. "According to a study by the International Monetary Fund that reveals the benefits of cut in the exchange rate for foreign trade, a 10% fall in the value of a nation’s currency can boost exports by an average 1.5% of GDP." – Fizz Aug 11 '18 at 18:12

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.

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  • 2
    Not my downvote, but the Lira has been losing strength long before the US quarrel. It has been sliding for years (though not as fast as the past few days). – JJ for Transparency and Monica Aug 11 '18 at 18:02
  • @JJJ, sliding, yes, but not quite free fall. I said that the move was connected with hard numbers, but the fact that it happened now (and not last month or next month) was psychology. – o.m. Aug 12 '18 at 6:01

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