Turkey woke up in the morning of May 23, which happened to be the eve of religious holiday Eid el-fitr, to a Presidential decree. It was about the rise in the tax rate imposed on transactions involving foreign currency sales from 2 per thousand to 1 percent, a fivefold increase. Separately, witholding tax rate on gains from commercial papers issued by banks with maturity less than one year term have been increased from 10 percent to 15 percent.
The 1 percent tax to be levied on foreign currency sales is quite high. In economic language, this is called “Tobin tax.” This is some sort of a capital control or foreign exchange control practice. However, those who impose it do not call it “capital control.” When they do not call it this, it does not mean that it does not fall into the same category.
“Tobin tax” was first suggested in 1972 by Nobel Economy Prize winner (1981) James Tobin when Bretton Woods system collapsed. In this system, dollar was indexed to gold, and other currencies were indexed to the value of dollar, but the fixed exchange rate system collapsed and fluctuation started in currencies. It was suggested for stability.
Ankara thinks it can obtain stability for its national money through the sale of foreign currency from the “back door,” which actually rapidly erodes reserves. Ankara has also resorted to banning Turkish Lira to foreigners and other restrictions on foreign currency, but these are actually some 50 year old tools from the 70s.
This means that Turkey has resorted to a new method which was not even used in the “old Turkey” of those days when during the fixed exchange rate regime when the tax was never above 1 per thousand.
Even the rate Tobin suggested was at a much lower level when he said, “Let’s say 5 per thousand.”
In a period when loss of confidence is triggered through awkward practices, the economy management in Ankara, leaves no ground left to protect the Turkish lira when it rapidly lowers the lira interest rate and brings it to a negative real interest.
They are now clinging on to doing make up to the balance sheet by borrowing other countries’ currencies by swap, so that they try to protect the Turkish Lira. They are also opting for a 70s model tax such as the Tobin tax.
The recent practices of imposing tax on those who buy foreign currency, the rule of “delivery the next day” in foreign currency purchases, the unlawful tight rein on banks are increasingly creating uneasiness for the saver. When “soft” tools for capital control have been started to be used, then individuals and companies that make up the economic units start asking, “Are the hard ones to follow these soft ones?”
As a matter of fact, as it happened in 2018 after the Brunson crisis, also after the COVID-19 crisis broke, the erosion in foreign currency accounts became remarkable. This erosion is not because of converting foreign currency to Turkish Liras. For instance, the drop in the foreign currency accounts in August 2018 and March 2020 is parallel with the drop in the foreign exchange banknotes vaults of the Central Bank.
While Ankara creates uneasiness for the savers this way or that way, it feeds exits from the system and supports purchases of gold.
The “demonizing” of those who buy foreign currency makes citizens and institutions, that want to protect their financial assets when under bad management, direct toward keeping gold.
The drop in foreign currency accounts, only with the start of the Covid-19 pandemic, from March 6 to May 15, is 10 billion dollars. The rise in gold accounts is 4 billion dollars (almost 60 tons.) in the same period. In total, as a result, foreign currency type accounts have a 6 billion dollar drop. (Central Bank data)
One of the waves that these steps toward capital control will bring is the formation of a “parallel market” in the foreign currency market. What we used to have domestically, which was called “mobile FX market” – which was unregistered foreign currency sales and purchases – will inevitably be reborn. It is inevitable because the exchange rates that the banks quote for a couple of kurushes (cents) will now have an additional cost of 7 kurushes with the 1 percent tax. In other words, an institution that would buy dollars from a rate of 6.80, if it sells it without any profit at the same rate 6.80, it will pay 6.8 kurush tax. Its cost to the buyer will be 6.8680.
Thus, even if there will not be any taxes levied on transactions between banks, the final client will have an extra cost of nearly 7 kurush in sales. For this reason, the margins of sales and purchases will inevitably widen. This, in turn, will shallow the market.
Another factor is that when domestic purchases of foreign currency for buyers are made more difficult through extraordinary methods and high taxes, this will eventually bring the formation of an “off shore” market. When the exchange rate is different domestically and internationally, then your currency is at another league where the convertibility is wounded.
All of these efforts using wrong methods to curb the foreign exchange rate will decrease the entry of foreign currency to the system in Turkey. In those places where either soft or severe capital control exists, from exporters and tourism investors to citizens and companies, all economic units adopt the tendency to keep the foreign currency outside without having it enter the system. This makes a more problematic situation and time.
If you have an advisor, a technical expert group and decision-makers who do not know what would happen if you take these steps, then they are plotting against you.
The desperate economy management that has damaged the convertibility that Turkey obtained for its currency in the past 30 years, is now relying on a tool box that belongs to the 70s. These desperate steps are pushing the entire economy into an even tougher path.
Unlike what those in Ankara who are managing the economy believe, 51 percent of the economy is not psychological perception, it is trust. Empires of fear do not generate trust.
Those who are ruling the country are spending so much energy on blaming vague foreign powers for all the wrong and bad management. If they could have channeled this energy to understanding the problems of the country, then we would have gone a long way and truly would have made these “foreign powers” envious of ourselves.
Turkish Treasury is “printing” forex bonds to create additional foreign currency for its own operations. Public banks, on the other hand, are spending their cash foreign currencies and replacing them with forex bonds the Treasury is printing.
For a long time, Ankara had eroded foreign currency reserves worth near 100 billion to hold the rate. Now, it has come to the end of the road. It has spent its last penny and left the rate to the markets. Thus, the “unheard of” invented exchange rate regime has collapsed.
Can the forex loss in Turkey be recovered without sending the bill to the public? If first signs of the establishment of political normalization, democratization and rule of law emerge in a powerful way in Turkey, then the “shrunken” foreign currencies will come back to the system.
If the ruling Justice and Development Party (AKP) sees an increase in erosion of their votes and the increased possibility of losing power in a possible election then it would "use all the ammunition till it is finished" for their own political continuity. But this would indeed mean leaving a “gigantic wreckage” for the citizens of the country.
The trend in that started just before the presidential elections in 2018 and accelerated after the elections changed the chemistry of the economy in Turkey. Private sector in Turkey was restricted in every aspect. From pricing to sourcing, to investment licenses, all regulatory higher bodies worked to make the entrepreneurs feel that ‘the party state’ was watching them at every step.
A currency, that is losing value and is not the good money to its own citizens, cannot be the good money of another country. Most probably those who declared they have switched to the Turkish Lira in Syria will be doing their payments in Turkish Liras and - even if it may be only a few pennies - they will keep dollars to store the value of their accumulation.
No matter how long or short the COVID-19 crisis lasts, a broad range of working masses, but especially the unskilled labor force will be the ones exceedingly affected. They will lose income and their jobs. As a result, inequality will spread on a mass scale and poverty will soar.
The economy management in Ankara may have this thought of stopping the devaluation of the Turkish Lira by wounding the lira’s convertibility but actually it also damages the debt capacity of the Treasury.
What would we have included if we wanted to write a guideline for those who have the wish to intervene in foreign exchange rates but who do not have the adequate experience, but at the same time want to do it right? Taking into consideration today’s circumstances in Turkey, here is a list.
In those countries where it is presented as they have a “floating exchange rate regime,” if their central banks are intervening at the exchange rate, the name of this in economy literature is “fear of floating.”
Since the COVID-19 crisis erupted, Turkish Central Bank’s reserves fell nearly 20 billion dollars. Now, the thought of “Can there be a swap line opened from the U.S. Central Bank Fedreserve ?” is in question.
Turkey was caught with the coronavirus outbreak at a time when it was weak structurally. Just like in the COVID-19 epidemic, the underlying disease story is the story of those problems in economy which were “swept under the carpet” for a long time. Turkish government's economy policies after 2018 were based on bans, limitations and covering up of the symptoms rather than resorting to necessary steps to solve the problems.
Ali Babacan's unfulfilled desire, the “fiscal rule” theme features in the program of the newly established Democracy and Progress Party’s (DEVA) . Babacan had made preparations to start the practice of fiscal rule in 2010, until Prime Minister Erdoğan shelved this.
Even though its name is “floating exchange rate regime,” the current one in Turkey can only be called “commanded foreign exchange regime.” Some may object to that and suggest “managed floating rate regime.” If it was the latter, then the Central Bank would have openly done it. Everybody would have been informed of a rate regime which has targets, a framework and a system. But we do not know anything about this “dystopian regime.”
Talking about Turkey’s economy is like a stand-up show. Turkey’s Central Bank is as independent as the Fed, says the Finance Minister. This comparison can be uttered because of the mood created in Ankara where the government commands the economy. But even in regimes of command economic, there is interdict and logic.
Politicians may have an inclination to regard the Central Bank as a “cow of the government to be milked.” But it is logic blowing that those who have undertaken CB jobs have rolled up their sleeves and personally worked for that.
In the last two years, the economic policy team governing in Ankara that has been intervening on prices, interest and exchange rates with an iron fist has cost banking executives their jobs for making their own trade decisions in an open market. Turkey is supposedly an open market economy, but Ankara has been nudging market players under the table to the point that the market is “open” only in theory.
Both the consumption and investment data in the third quarter show a tendency toward “exhausted growth” in the private sector. I wrote at the end of October that this is the picture of weak, anemic growth. The economy is out of energy. With the economy in this weak and feeble state, Ankara cannot carry the country politically to 2023.
The "orchestrated" issue on the agenda last week was an effort to form public opinion about punishing comments on economy by jail sentences and monetary fines. Stories in newspapers were followed by a speech by Economy Minister Berat Albayrak the next day, who wanted to lay "thought infrastructure" for this.
Russia's strategy is quite clever; it continues to accumulate reserves by using dollar and euro for its exports while using ruble for one third of imports. By receiving 7-8 percent of its net foreign trade in ruble, it creates demand for its currency at the same time.More so, Russia is trying to recruit Turkey as a customer for its Russian made SWIFT alternative SPFS and again homemade credit card system MIR.
The three-way wheel of the Turkish economy, which depended on the flow of foreign capital, domestic credit growth, and household consumption, has stopped. It seems like the politicians running the country in Ankara couldn't find the answer to "What awaits the Turkish economy in 2020?"—since they undertook a military operation in Syria to get back the votes they lost due to the economic crisis.