Turkey’s Plan to Save the Lira Is a Risky Bluff

Volatility in the currency has also jumped. Investors may be weighing the chances that the program will mobilize sufficient funds. “People are waiting to see if there are a lot of Turks who do it,” said Can Erbil, economics professor at Boston College, who believes Mr. Erdogan may be trying to rally his base by being seen to oppose foreign forces.

Yet these measures are a tacit admission that foreign forces are no longer steering the lira. Whereas the start of Turkey’s currency crisis in 2018 was exacerbated by international investors refusing to roll over the financing they previously extended to Turkish banks—money that fueled a corporate dollar-borrowing binge—now it is mostly locals fleeing the lira. Even as foreigners have bailed out, banks’ foreign-currency deposits have risen 2% this year, putting them on a par with lira deposits.

Overall bank deposits have proven quite stable. Perhaps the Turkish financial system retains enough credibility for the new program to trigger the kind of virtuous cycle the currency needs to stop falling.

But confidence feedback loops can be dangerous too. If the market calls the bluff and tests the lira, there are still lira deposits amounting to 30% of the Turkish economy liable to be dollarized, and the government could be on the hook for almost limitless compensation.

That would, in turn, undermine confidence in its banks, and here is why. In recent years, Turkish lenders have reduced to around $94 billion the debts they owe to overseas creditors. During the 2013 to 2018 boom this number rose to $150 billion, far larger than the banks’ liquid foreign exchange assets of $25 billion. Even the central bank’s reserves didn’t cover the shortfall. After a painful adjustment, including a short recession, banks have doubled their liquid assets and cut down on dollar loans—they now have $94 billion more in foreign-exchange deposits than loans. The central bank has meanwhile replenished its reserves.

But there is a catch: Without a ready supply of hot money from overseas, officials turned to the banks themselves for foreign currency. Banks currently hold about a third of the government’s debt—including $22 billion in foreign-currency bonds, compared with almost none before the crisis. The central bank’s official reserve figure is also flattered by a continuous $63 billion swap arrangement with lenders and allied governments, excluding which its pot is deeply negative.

In short: If the Turkish public sector is overwhelmed by domestic payment needs and can’t make good on dollar debts, the domestic financial system will bear the brunt. Meanwhile, Turkish companies are borrowing less, but their external-debt burden isn’t getting smaller either. While no big payments are coming soon, Turkish bond yields have shot up, making rollovers more expensive, whether rates rise or not.

Ultimately, keeping faith in the lira will be hard when inflation is at 20% and the depreciation that has already happened is set to erode purchasing power for months to come. Without credible central-bank policy or capital controls, Turkish savers may prove to be only a little less fickle than global money managers.

Write to Jon Sindreu at jon.sindreu@wsj.com