Trust is slowly won but quickly lost. It has taken several years for Turkey to regain the confidence of international investors after president Recep Tayyip Erdoğan’s unorthodox economic policies stoked massive inflation. News on Wednesday that the president’s main political opponent has been detained by local police will undo much of that work.
The Turkish lira dropped more than 10 per cent before reversing some of the losses. The benchmark Bist 100 index fell 9 per cent, while its benchmark local currency bond had its worst day since 2023.
The timing of Wednesday’s sell-off is particularly painful for international investors, who had been increasing their exposure to Turkish assets. Foreign holdings of Turkish bonds and stocks increased 50 per cent over the 12 months to March 7, to around $54bn, according to data from the Turkish central bank and Bloomberg. That is more than triple the low point hit in 2022.
Bets on lira appreciation have been one of the most popular recent trades among emerging market currency investors, according to Jupiter Asset Management, while high real interest rates had made short-dated government bonds particularly popular with hedge funds.
International inflows were the result of a confluence of factors. The short-term economic picture has been improving since a return to more mainstream policies after the 2023 election. GDP is expanding, and the official rate of inflation has slowed from its peak of over 85 per cent. The relative stability has also made it easier to think about Turkey’s longer-term potential.
Recent developments on the international stage — including a tentative peace progress with Kurdish insurgents and Turkey’s influential roles in seeking to resolve the conflicts in Ukraine and Syria — had also contributed to investors’ rising confidence, outweighing any concerns around a growing crackdown on domestic opponents.
This week’s escalation could cancel that out. From a fundamental standpoint, market moves will make it harder to maintain the economic momentum — a weaker lira, for instance, hampers efforts to bring inflation under control.
And when it comes to emerging market economies in particular, politics are fundamental. Mehmet Şimşek, the country’s well-respected finance minister, has tried to reassure investors that the government is not about to change direction on economic and monetary policy.
But investors in Turkey have been burned before. The worst-case scenario is a return to presidential pressure to keep interest rates low and late-night central banker firings. If they believe Erdoğan is backsliding on the rule of law or focusing entirely on domestic political battles, they may lose faith in the resilience of the economic reforms too. A regime that has lasted more than 20 years is no guarantee of stability — and may be the opposite.
nicholas.megaw@ft.com
