US forces could be caught in the crossfire if Turkish President Recep Erdoğan makes good on his vow to attack Kurdish forces in Manbij. Photo: Reuters

Turkey’s stock market has lost 17% in Euro terms since its late-August high point, courtesy of Turkish President Recep Tayyip Erdogan overplaying his hand with Western allies. 

The crisis in US-Turkish relations had been building for weeks, but became an open rupture when the US State Department suspended visa approvals for Turkish citizens traveling to the United States after Turkish police arrested a Turkish employee of the American embassy at Ankara for alleged participation in last summer’s coup attempt. The US denounced the arrest and dismissed the charges as “wholly without merit,” suspending visa approvals, and the Turkish government reciprocated with a similar ban.

Turkey’s diplomatic turn towards Iran and Russia is the driver in the diplomatic crisis, although Western countries have long rankled at Erdogan’s brash assertion of Turkish power. Erdogan has made common cause with Iran against the attempt by Iraqi Kurds to form their own state, as Asia Times first reported on June 27.

In early September, US federal prosecutors charged top Turkish bank executives and a former Turkish economics minister with laundering hundreds of millions of dollars for Iran. The Erdogan government denounced the US and defended its bankers, who include top executives of Halk Bankasi, one of the country’s largest banks. Asia Times’ financial blog Asia Unhedged warned on September 8 that “Erdogan may have stretched his neck out too far this time.”

That is a sharp turnaround from last January, when Washington as well as Moscow wanted Erdogan to succeed. The incoming Trump Administration hoped that a Russian-American deal would stabilize Syria, and that Turkey would act as a counterweight to Iranian ambitions inside Syria. Washington wanted Turkey to remain inside NATO; the Europeans wanted Erdogan to staunch the flow of refugees (which he had backhandedly encouraged in 2015);  and the Russians wanted his help in neutralizing Sunni jihadists, whom Erdogan had helped off and on. China wanted Turkey to be the western terminus of its Belt and Road infrastructure project.

“The collapse of the lira isn’t just a psychological problem for Erdogan. On the contrary, the whole Turkish economy will come under pressure as a result”

This benign geopolitical backdrop supported the Turkish stock market, which until August 30 was the world’s top performer, up 50% in dollar terms since its January 2017 low point. Erdogan overplayed his hand badly, however. Turkey announced that it would purchase Russia’s S-400 air defense system, a slap in the face to NATO, whose southeastern flank Turkey had guarded since the beginning of the Cold War. His open alliance with Iran, moreover, destroyed Washington’s hope of establishing a balance of power in Syria. The Syrian Kurds had been the most effective fighting force against Sunni jihadists, and Erdogan now threatens to use the Turkish armed forces against the Kurds. That gives Iran a free hand to expand its military presence in Syria, including the construction of a military airfield near Damascus, according to Israeli press reports.

Erdogan’s dalliance with Iran wrong-footed Washington’s efforts in Syria, and it is not surprising that the first rupture in American-Turkish relations came over Turkey’s covert financial help for Tehran.

Erdogan now finds himself without friends in the West. Turkey has jailed twelve Germans of Turkish descent for alleged involvement in the July 2016 coup attempt, over the strenuous protests of the Berlin government.

Now, Erdogan is getting his “payback,” Holger Zschäpitz writes in the Berlin daily Die Welt. “The collapse of the lira isn’t just a psychological problem for Erdogan. On the contrary, the whole Turkish economy will come under pressure as a result.” Turkish companies have nearly US$300 billion in loans denominated in foreign currency, according to central bank data, equal to about a third of total GDP. The interest burden on these loans rises as the value of the Turkish currency falls. Turkish inflation already is running in double digits.

Even worse, Turkey is dependent on so-called “carry trade” investments of short-term money seeking high interest rates in Turkish assets, which pay more than 10% interest. Investors who reached for high Turkish yields got burned during the past month as the Turkish lira collapsed. Turkey’s current account deficit is running at 4% of GDP, and its currency remains vulnerable to further decline.

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