Turkey’s lira fell to a record as the country’s latest diplomatic spat with the U.S. and other foreign governments gave traders another reason to sell the struggling currency.
The lira retreated as much as 2.5% in early Asian trading amid thin liquidity on Monday, touching a new low for a third day. It was 1.5% weaker at 9.7509 per dollar at 10:48 am. in Istanbul.
Already under pressure following a larger-than-expected rate cut last week, the currency encountered fresh selling after President Recep Tayyip Erdogan said on Saturday that the ambassadors of 10 nations were no longer welcome after they demanded the release of a prominent government critic. Investors are watching for the Turkish Foreign Ministry to make the move official.
The possible “personae non gratae declaration compounds the increasingly acute economic challenges facing the country,” according to Ehsan Khoman, head of emerging market research for Europe, Middle East and Africa at MUFG Bank in Dubai. Lower investor confidence could spur “a precipitous and disorderly lira depreciation.”
Erdogan has long sought to portray himself as his country’s bulwark against hostile foreign powers to appeal to nationalist voters.
His call to expel the envoys of countries including the U.S., Germany and France for demanding freedom for philanthropist and businessman Osman Kavala coincides with opinion polls suggesting his support base is eroding as the cost of living soars.
The risk is that his rhetoric may end up worsening that fragile economic backdrop.
“His decision is likely to increase the selling pressure on the lira, which will have negative consequences for inflation,” said Piotr Matys, a senior currency analyst at InTouch Capital Markets in London.
The currency has lost 24% versus the dollar this year, the worst performer in emerging markets. The lira’s one-month implied volatility rose to the highest since May on Friday.
Previous bouts of tension between Turkey and other countries — especially the U.S. — have taken a toll on lira assets, leading to wild swings in local financial markets. The country suffered a currency crisis in 2018 over the fate of an American pastor who was imprisoned in the country.
A U.S. official said the administration is aware of the reports out of Turkey and is seeking clarification from the foreign ministry in Ankara.
The latest diplomatic flare-up centers on businessman and philanthropist Osman Kavala, who has been jailed for four years in a case that’s become a test of the independence of the judiciary and the rule of law in the eyes of some foreign governments.
The spat puts Erdogan in an awkward position just a week before a Group of 20 nations summit takes place in Rome, where the Turkish president is hoping to meet with U.S. President Joe Biden.
No meeting has been confirmed yet and a new diplomatic crisis over the envoys — should they be expelled — will hardly make it easier for Erdogan to get the face time he needs to negotiate a solution to some of the earlier problems plaguing the bilateral ties.
Erdogan wants to lobby Biden to allow Ankara to buy dozens of American warplanes, in a bid to overcome Washington’s resistance to major arms deals with his country following its purchase of Russian air defenses.
Investors have become used to nationalistic rhetoric from Erdogan that often stops short of sparking a full-blown diplomatic crisis.
However, local markets are arguably more vulnerable now as foreign ownership of Turkish bonds and stocks has slumped to new lows. They hold less than 5% of local-currency government debt, down from close to 30% in 2013, and local investors can be more sensitive to swings in the political mood.
Still, Erdogan’s latest comments won’t bother foreign investors as much as the recent interest-rate moves, said Hasnain Malik, the Dubai-based head of research at Tellimer Research.
“Nearly 20% inflation and a negative real interest rate are the real problems, not Turkey’s foreign policy,” Malik said.