Last week, the US Treasury announced sanctions against two Turkish cabinet ministers over the detention of an American pastor. This did not come as a bolt from the blue: in the past few years, Turkey has often been at odds with the EU and US in both its domestic and foreign policies. US president Donald Trump has previously threatened Turkey with sanctions if it goes ahead with its plan to purchase an S-400 missile system from Russia, and the US is investigating state-controlled Halkbank for breaches of Iranian sanctions. Now Bloomberg is reporting that the US has also prepared a broader list of Turkish entities and individuals that could be subject to further sanctions. To predict how Turkey would fare, we should look to the experience of the Russian economy after Russia annexed Crimea in March 2014. At the time, its economic growth was near its potential, it had low debt levels and the central bank held net foreign exchange reserves of $470bn. But the “biting” EU and US sanctions introduced after the invasion triggered a currency crisis, followed by a two-year recession. Russian institutions were cut off from international capital markets and unable to roll over their debt. Demand for forex soared. The crisis combined with falling oil prices to force a 50 per cent devaluation in the rouble against the dollar. Fortunately for the economy,

President Vladimir Putin had delegated economic policy to a team of technocrats. The central bank courageously floated the rouble and raised its policy rate by 750 basis points in late 2014. Containing the crisis came at a cost: the government ran down one of its sovereign wealth funds, and the central bank’s net forex reserves fell by more than $150bn. However, Russia avoided capital controls and the central bank enhanced its reputation for independence. In contrast, Turkey’s overheated economy expanded by over 7 per cent in 2017. This was accompanied by a widening current account deficit and moderate growth of the budget deficit. Although Turkey’s public debt is relatively modest, external debt is much higher as a percentage of gross domestic product than that of Russia in 2014. Unlike Russia, Turkey does not have a sizeable fiscal or foreign exchange cushion. With its net foreign exchange reserves of only $74bn, the Turkish central bank has very limited ability to help local businesses refinance forex debt. Crucially, Turkey is as dependent on investment flows as Russia is on oil. Global investor flight from emerging market assets has weakened the Turkish lira by 25 per cent versus the dollar this year. This has fuelled inflation and made further lira depreciation highly undesirable for Turkish authorities. I think that the new US sanctions have increased the odds of a balance-of-payments crisis in Turkey. I worry about the heavily indebted corporate sector. Turkish banks have about $55bn in forex deposits but they face heavy external debt repayments in the next 12 months. Both Turkish banks and companies need to retain access to external markets. To regain investor trust,

Turkish president Recep Tayyip Erdogan would do well to follow Mr Putin’s example by putting experts in charge of economic policy, and allowing the central bank to reassert its independence. But Turkey’s shift in July to a more powerful executive presidency leaves little hope for independent institutions. Last month, the central bank eschewed another rate hike despite soaring inflation; its decision came right after Mr Erdogan predicted that rates were poised to fall, which unsettled the markets. Mr Erdogan hopes that Turkey will attract more loans from China and other emerging market countries, much as Russia has done. But the Russian experience shows that some foreign direct investment may be substituted, but that takes time. Turkey needs to repair its relationship with the west quickly to avoid a larger crisis.

Source : www.ft.com