Key elections are imminent, the Turkish financial market is in chaos

The turmoil in the Turkish financial system continued to spread on Wednesday, the stock market fell sharply, borrowing costs rose, and the government denied trying to prevent foreign investors from shorting the Turkish currency.

The Istanbul Stock Exchange 100 Index (BIST 100 Index) fell 5.7%, the biggest one-day drop since July 2016, the Turkish dollar bond plummeted, and the insurance cost of Turkish bonds jumped to its highest level since October last year. The lira reversed the gains of the previous trading day and fell 2% against the dollar on Wednesday.

On the occasion of financial market turmoil, Turkey is about to hold key local elections. A few days later, Turkish President Erdogan’s party will compete for power in key cities such as Istanbul and Ankara. Against the background of deteriorating economic conditions, rising inflation and rising unemployment, he warned that he would punish speculators.

Analysts and investors say the authorities have taken action to crack down on short-selling deals in the international money market (especially London). But Richard Segal, an emerging market analyst at Manulife Asset Management, said: "These measures seem counterproductive. The more intense the situation, the greater the risk of losing control."

Analysts and investors believe that after a wave of short selling, the Turkish authorities have urged local banks to raise financing costs. The lira overnight swap rate (a measure of Lira's borrowing costs) jumped from just over 20% last week to over 1000% on Wednesday. This makes the short-selling lira investors punished.

The Turkish Banking Association said that the shortage of lira led to an increase in swap interest rates, but the association denied that the Turkish bank had anything to do with the current situation. The association said in a statement: "Turkey banks are eager for the liquidity of the lira."

In a report to clients, German Commercial Bank analysts wrote: "The root cause is related to Turkey's macroeconomic imbalances, continued high inflation and the central bank's reluctance to raise interest rates further. These interventions will not be able to contain the weakness of the lira."