With the Turkish economy struggling, President Recep Erdogan keeps pushing through an expansionist foreign policy and using harsh rhetoric in the international scene.

The current indicators highlight that unless some of Erdogan’s fundamental policies are promptly reconsidered, Turkey could be soon facing an unprecedented systemic crisis.

Ankara’s Many Open Fronts: from Tripoli to Artsakh

It goes without saying that the increased geopolitical risk and the extended uncertainty over the security landscape of a country can have a grave impact on the economic outlook and the standing of the national currency across global markets. This is exactly the case with the Turkish economy at the moment, as Ankara is getting more and more involved in several fronts across the Mediterranean and the Caucasus regions.

Syria was the first country, where Erdogan tried to expand Turkish regional influence through consecutive operations in Idlib, Afrin and North-Eastern Syria. He did this in order to mitigate the Kurdish element in the proximity of the Turkish borders. Since early 2020 Turkey has been engaged in skirmishes with Syrian regime forces, a development that troubles Russian-Turkish relations. These bilateral relations have been further tested amidst the escalation of the Libyan civil war, where Turkey has also been heavily involved for over a year now, backing the Tripoli-based Government of National Accord; we should mention here that the forces fighting the GNA in Libya are being backed either politically or materially by a wide coalition, including France, Egypt, UAE, Russia and Greece. This proxy conflict is indirectly creating an antagonistic context between these countries and Turkey.

Finally, the latest engagement in the ongoing and ever escalating Nagorno-Karabakh conflict, where Ankara is decisively supporting Azerbaijan, which has once again put Russia and Turkey in opposing sides. The bottom line is that this unprecedented involvement concurrently in several different fronts has not only created a vast burden for the Turkish economy, but also prompted international concerns about Ankara’s rogue and unpredictable policy, while putting at stake traditional alliances like the one with Moscow.

Maritime Boundaries and Macron’s Mental Health

In the field of foreign policy and international relations, Turkey is by no means doing better, causing numerous political and diplomatic stalemates and clashes. Since July 2020, Turkish vessels have been constantly moving across parts of the Greek and Cypriot respective continental shelf and exclusive economic zone. Turkey is seeking to establish this way de facto rights in the Greek and Cypriot zones, a strategy which is seemingly successful so far. These moves have reportedly brought the two sides in the verge of an armed conflict; even though the perspective of a war is highly unlikely, a serious escalation can bring severe short-term downfalls in the country’s currency.

It should be noted that by late July during the first crisis with Greece, the Turkish lira lost almost 2% of its value against the US dollar within three days, while on August 5, during the second phase escalations, this drop increased to approximately 4.5% in just two days. The Greek and Cypriot sides are also demanding from the EU to impose sanctions on Turkey, an action that would have a devastating effect on the Turkish economy at this pivotal moment, however this scenario is rather unlikely, considering the special relation between some of the EU leading countries and Ankara.

At the same time, following the killing of French teacher Samuel Paty’s, French-Turkish relations have probably reached their lowest point ever, with Erdoğan publicly stating that the French President Emmanuel Macron, needs mental health treatment. The response from Paris was to withdraw the French Ambassador from Turkey.

The friction between France and Turkey of course lies in deeper political, economic and security antagonisms across the Middle East and Africa, so this diplomatic escalation now should come as no surprise. Shortly after Erdogan’s mental health remarks, Josep Borrell, the European Union Minister for Foreign Affairs, harshly criticized President Erdogan’s unacceptable comments, further worsening the international standing of the Turkish economy and the country itself.

Benchmark Interest Rates and Foreign Currency Reserves

Before discussing the present situation in Turkey, it’s worth having a quick look at the significance of benchmark interest rates. The benchmark interest rates are adjusted by the Central Bank of a country and are used as the base point of reference for all the financial transactions and products within the country; in a very simplified way the benchmark rates dictate the cost of lending within the country.

The benchmark rates should be modified according to the performance of an economy, so the given economy can be treated as reliable in the international system and global markets. Due to the long-standing and ever-increasing economic crisis in Turkey, President Erdogan is fiercely opposing the increase in the benchmark interest rates. Erdogan believes that low lending costs across the country could keep the economy moving in this challenging period, ignoring the fact that this approach could eventually lead to a huge credit bubble. Indeed, such a strategy could increase the country’s systemic risk and make the danger of a default more likely.

The Turkish Central Bank, under Erdogan’s close guidance, has been also persistently rejecting calls to increase its benchmark interest rates, with an exception in late September, when the rates were increased by 2% stabilizing the rate at 10.25% giving a short-lived boost to the Turkish currency. Erdogan has been struggling to keep the rates at one-digit values, prompting distrust across the global markets and plummeting the value of the Turkish lira.

At the same the in-country foreign currency reserves have been drastically reduced over the course of the last months. At the moment, the foreign currency reserves of the Central Bank of the Republic of Turkey (CBRT) have plummeted to 36.3 billion US Dollars from 75.8 billion USD in February 2020, an approximately 52% massive decrease in just a few months. As FT’s Laura Pitel has highlighted, this drastic reduction on the country’s foreign reserves could have already eliminated the defenses against a possible currency or BoP crisis.

Mid-term Outlook and Conclusions

According to the current mid-term outlook of the CBRT, the already high inflation is expected to reach 12.1% by the end of 2020 and then turn downwards to 9.4% by the end of 2021, with a 5% stabilization rate in the mid-term. However, this forecast is based upon the optimistic notion that the renewed wave of COVID-19 cases worldwide will not bring significant restrictions and will not affect the risk appetite in the international level.

We can easily understand that the CBRT projections are rather over-optimistic. Even though Turkey is trying hard to present a low rate in COVID-19 reported cases and deaths, it remains to be seen if this could be viable in the following months, as the virus’ second wave surges.

In terms of foreign policy, Erdogan should understand by now how important it is for his very political survival to adopt a clear strategy regarding Turkey’s alliances and enmities in the global scene. Turkey is currently by no means in position to follow a fully independent policy, and under no circumstances could it emerge as one of the main moving forces in the contemporary unipolar system.

Unless he is smart and agile, President Erdogan faces the risk of confronting too many enemies at once, eventually triggering a shocking devaluation of the Turkish lira and a potential collapse of the Turkish economy.