Presidential Showdown: Trump-Erdoğan

Discussion and analysis by Grace Gliksten:

A month of souring relations with the EU has ended with Turkey in a stalemate with the US following a mutual suspension of visas. The Turkish Lira has unsurprisingly been hit harder by the event than the US Dollar which, surprisingly, still showed a perceptible weakening.  

Following the arrest of Metin Topuz, a Turkish employee of the US embassy, last week, relations between Turkey and the US have worsened, precipitating a vicious tit-for-tat reciprocity. While the Turkish government has provided no information concerning the arrest, the Turkish media has conjectured that Topuz was arrested for ‘facilitating the escape of known Gulenists’, followers of Fethullah Gulen whom Turkey accuses of being behind last year’s coup attempt. Visas were suspended mutually between the two countries despite the healthy diplomatic stance that both leaders displayed regarding their mutual foreign policies last month. The US ambassador has insinuated that certain Turkish officials were trying to unsettle relations between the countries while the Foreign Ministry in Turkey has claimed that the suspensions have shown ‘unnecessary victimisation’.

Relations between the two countries have been tense since the Obama administration and have slowly become deeper, despite the initial assurance from Erdogan that mutual cooperation could flourish. Erdogan believed that, under Obama, the US was too supportive of the Syrian Kurds, whom he believes to be an extension of the Kurdistan Workers’ Party, or PKK, which both countries have designated as a terrorist organisation. Moreover, the Turkish President was aggrieved by the failure of the US government to extradite Gulen upon Turkey’s request, despite US officials claiming the evidence provided by Turkey to be insufficient.

Whilst being marked as one of the worst performing currencies of 2016, the Turkish Lira found itself in new territory, strengthening against the US Dollar for seven months in a row this year. The Lira increased by 8.49 percent between February and August 2017 for the first time since the currency became convertible in 1989, likely on the back of tightening monetary policies that signalled the sensibility of the Central Bank of the Republic of Turkey and an increased reward for investment. The Lira began depreciating against the US Dollar in September after Angela Merkel’s calls for an end to Turkey’s membership bid; a trend also reflected within the Euro and Pound Sterling. Talks between the EU and Turkey have been left frozen for some time now, with EU officials growing worried that Erdogan’s Turkey is becoming more and more authoritarian under his rule.

Two year graph of USDTRY, GBPTRY and EURTRY: Exchange rate of the Turkish Lira in US Dollars, Pounds Sterling and Euros respectively in the medium-long run. The Turkish Lira is shown to be at seven-month-long highs against the US Dollar between February and August 2017. Despite periods of Lira strength against the Euro and the Pound Sterling, a similar, elongated, trend cannot be found.

The EU is, however, stuck between a rock and a hard place when it comes to rejecting Turkey’s membership bid. The EU has a crucial refugee deal with Turkey whereby Turkey has helped stem the flow of refugees trying to enter into Europe since the beginning of the crisis in 2015. Hosting almost 3.5 million refugees, surpassing any EU member state and accounting for almost three times the number in Germany. Erdogan’s apparent commitment to his agenda is causing the EU further concern. The referendum in April, won by a narrow 51.4 percent of accepted ballots cast, granted Erdogan new powers, adding to fears that Turkey will snowball into authoritarian rule. This includes the power for the president to intervene in the judiciary and the scrapping of the job of prime minister. The new system could see Erdogan in office until 2029.

The Lira hit 12-week lows this week against an already appreciating US Dollar. The Lira depreciated by 3.6 percent against the US Dollar and by 3.88 percent against the Euro on Sunday night. The significant depreciation was caused by to the combined effect of strengthening the perception of Turkey as an undemocratic and insular nation, as well as a pricing in of lower future demand for Turkish Lira by US citizens. The US is the fifth biggest market for Turkish exports, while Turkey only makes up 2.1 percent of US exports. Although minimal, there was a small effect on the US Dollar, shown in the differential between Lira crosses other than the Dollar and the USDTRY spot exchange rate. This can be attributed to two factors. Firstly, the demand for US Dollars in Turkey will have decreased due to the mutual visa suspension. Turkish nationals formerly travelling to the US may no longer need US dollars, weakening demand.  Secondly, there will be a natural, albeit small, effect on confidence within the US Dollar, because the diplomatic actions between the US and Turkey are mutual; just as US visas are to be withheld from Turkish citizens, so too are US rights to Turkey.

One week graph of USDTRY, GBPTRY and EURTRY: Exchange rate of the Turkish Lira in US Dollars, Pounds Sterling and Euros respectively in the short term. The amplitude of the US Dollar change is smaller than its Euro and Pound Sterling counterparts.

The relative importance of the Lira to the Dollar is minimal, shown by the negligible percentage change between the US Dollar and the Euro.  Analysing the net effect of Dollar weakness stemming from Turkish sanctions against US visitors is futile because of both the trading and political significance of Turkey to the US. As a major international reserve currency, a mark of stability, and a conduit for international trade, there is ample demand for the US Dollar outside of Turkey. As the same can’t be said for Turkey, the Lira took a far bigger hit.