Analysts had become accustomed to seeing Turkey as vulnerable, clearly unbalanced and badly governed but did not feel that a crisis was imminent. Almost all agree that the country is capable of bailing itself out just in time through a rate hike.
Unbalanced growth is driving a vicious cycle in which lira depreciation drives inflation, forcing a rate hike, motivating fiscal stimulus, driving up core deflation, leading to further depreciation. The government has no intention of fixing imbalances and this means that the underlying problems will get worse and worse. At some point Turkey will run out of time.
The foreign debt issue is a symptom of the underlying malaise: unbalanced growth. This external vulnerability is heightened by FX dynamics: "hot money" continually floods in and out of the system in search of carry from high interest rates and as a result the whole economy suffers from resultant FX volatility. In short, Turkey has a whole new set of vulnerabilities, only it is no longer an issue of banks relying on the government to be solvent, but of the banks relying on external finance to remain solvent.
Turkey's relations with the EU and US appear to be stuck in a long-term pattern of decline. This is a bumpy process which has an almost limitless capacity to produce short-term shocks of exactly the kind that can trigger hot money to flood out.
Fed hikes are coming and benign conditions will not last. Turkey will fall into crisis. The next time intense lira depreciation hits, it will be time for investors to leave the casino.
The economy continues to deteriorate but the government refuses even to raise rates until June 2018. Turkey and the US fall into a major political crisis. TKY loses 45% of its value between our publication date and August 2018. Turkish stocks fall 20% in the same period (28% from the January peak) and the government/central bank is forced to raise rates to 25.50% by September 2018.