The Turkish Lira: Depreciation, Carry, and the Iran War Shock

How the lira got here

The Turkish lira has depreciated against the dollar in almost every year since 2008. The exchange rate stood around 1.1 TRY per dollar at that time. It now trades above 44. That is not a market finding fair value in a volatile way — it is the cumulative result of inflation running persistently above that of Turkey's trading partners, a structural current account deficit, and, for a particularly damaging stretch between 2021 and 2023, a central bank that was actively cutting interest rates while inflation was accelerating.

The political logic behind that episode was unusual. President Erdoğan held the view that high interest rates cause inflation rather than cure it — that raising the cost of borrowing raises production costs, which businesses pass on as higher prices. The argument has a loose theoretical basis in cost-push economics, but it does not apply to an emerging market with a depreciating currency and large external financing needs. The result was that the CBRT cut its benchmark rate from 19% to 8.5% between 2021 and 2023 while inflation rose above 80%. The lira lost roughly 60% of its value over that period. Three central bank governors were dismissed for resisting the policy direction.

In mid-2023, Erdoğan reversed course. Finance Minister Mehmet Şimşek and a new CBRT governor were appointed, and rates were hiked aggressively from 8.5% to 50% over nine months. Inflation has been declining since its 2024 peak of approximately 75%. The easing cycle has since begun, with the policy rate now at 39.5%. The lira has stabilised in a relative sense — it continues to depreciate, but in a controlled and predictable manner rather than in disorderly lurches.

The inflation–depreciation loop

The core mechanical problem is straightforward. Turkey imports roughly 90% of its energy and large quantities of consumer goods and industrial inputs. When the lira weakens, every one of those imports costs more in local currency terms. Higher import costs feed through to production costs, transport, and retail prices. Inflation accelerates. Rising inflation erodes the real return on lira-denominated assets, which reduces the incentive to hold lira, which creates more selling pressure on the exchange rate, which makes imports more expensive again.

Breaking this loop requires either that the currency stabilises long enough for inflation expectations to reset, or that interest rates are held high enough and long enough to credibly anchor those expectations. Turkey has made meaningful progress on both since 2023. But the process is slow, and any external shock — a political crisis, a reversal in global risk appetite, or a surge in energy prices — can set it back significantly.

The Purchasing Power Parity mechanism. When Turkish inflation runs 30 percentage points above US inflation, Turkish goods become more expensive for foreign buyers at any fixed exchange rate. Export competitiveness erodes, the trade deficit widens, and the market pushes the exchange rate lower to rebalance. This is not a decision made by any single actor — it is the aggregate result of millions of trade and investment flows repricing the currency to reflect the inflation differential.

Carry trade dynamics

With policy rates between 40% and 50%, Turkey has offered one of the highest nominal yields among major emerging markets. This creates a carry trade: foreign investors borrow in dollars at 5%, convert into lira, invest in Turkish government bonds at 40%, and collect the interest rate differential. As long as the lira depreciates at a pace smaller than the yield spread, the trade generates a positive return in dollar terms.

The CBRT has actively managed the depreciation pace to keep this viable — allowing roughly 15–20% annual depreciation against a nominal yield of 40–50% leaves a meaningful positive carry margin. This attracts capital inflows that help finance the current account deficit.

How covered interest rate parity prices the forward

The forward market does not offer a free lunch. If Turkish rates are 40% and US rates are 5%, the one-year forward rate for USD/TRY is priced approximately 35% above spot to reflect the interest rate differential. If spot is 44, the one-year forward trades around 59–60. The market builds the expected depreciation directly into the forward curve. Selling lira forward at that rate means locking in that depreciation as a cost — the interest rate advantage is fully offset.

Three types of participants actually bear the currency risk:

• Turkish exporters selling future dollar revenues forward to lock in a known lira amount. They accept the forward rate for certainty rather than speculation.
• Banks running hedged carry positions, borrowing in dollars, investing in lira instruments, and hedging the currency exposure. The residual profit comes from small basis differentials between onshore and offshore rates.
• Unhedged speculators explicitly betting that the lira depreciates less than the yield spread. If the lira falls 18% and the investor earns 40%, the net return in dollar terms is approximately 22%. They are the ones bearing the full currency risk.

Why the managed framework makes the trade viable

The CBRT's controlled depreciation path is what makes the unhedged position tolerable. Because the central bank actively smooths the path — intervening in the FX market to prevent disorderly moves — the distribution of outcomes is unusually narrow for an emerging market. The lira rarely gaps down 20% overnight. That predictability is what justifies carrying the unhedged exposure: the variance is low enough that the yield spread justifies the risk.

Where it breaks down

When an external shock hits, that predictability disappears. The CBRT may sell reserves to slow the move, but if the pressure is large enough, the rate moves much faster than the managed pace. Unhedged carry positions face losses that exceed the yield earned, and the exit is crowded. Goldman Sachs flagged this in mid-2025, noting that the CBRT was deliberately allowing faster depreciation in part to discourage excessive hot money positioning that would make a future unwind more disruptive.

Real rates: less restrictive than they appear

A policy rate of 39.5% sounds tight. Against inflation of 33%, the real rate is approximately 6–7 percentage points positive — meaningful by Turkey's historical standards, where real rates were deeply negative for much of 2019–2023. That positive real rate is the primary reason the disinflation process has worked since 2023.

The concern is that the easing cycle has been moving faster than the disinflation. The CBRT cut rates by 250 basis points in September 2025 and has continued cutting since, even as inflation has proved sticky in the 30–33% range rather than converging toward the official year-end 2026 target of 16%. Each cut compresses the real rate margin. If inflation re-accelerates — which the Iran war oil shock is now threatening to cause — the real rate could turn negative before the CBRT has time to respond. That risk is now being priced into Turkish assets.

The Iran war and the oil price transmission

The conflict that began in late February 2026 has introduced a layer of pressure that Turkey is structurally poorly positioned to absorb. Turkey imports approximately 90% of its energy, with an annual energy import bill of $60–65 billion. Iran supplied around 14% of Turkey's natural gas imports before the conflict. Russia and Azerbaijan supplied 37% and 21% respectively.

Brent crude surged 10–13% in the initial days of the conflict, briefly approaching $120 per barrel before settling back around $90. The transmission into Turkey's economy runs through three distinct channels:

Current account. Each $10 increase in oil prices widens Turkey's current account deficit by an estimated $2.5 billion and adds approximately one percentage point to annual inflation. A sustained $30 per barrel increase implies an additional $7–8 billion on the current account deficit and 3–4 percentage points added to inflation — pushing the 16% year-end target significantly out of reach.

Capital outflows. Foreign investors sold an estimated $25–30 billion in Turkish assets in the weeks following the outbreak of hostilities, preferring to hold dollar cash rather than remain exposed to an emerging market sitting on Iran's border. The CBRT sold approximately $12 billion in foreign exchange reserves — roughly 15% of its total — to slow the resulting lira sell-off.

Tourism and services. Iranian missile attacks toward Turkey's Adana province, though limited, raised concerns among foreign visitors about proximity to the conflict. If the summer tourism season is disrupted, Turkey loses one of its main current account offsets. Tourism revenues have historically provided $40–50 billion annually.

Finance Minister Şimşek acknowledged publicly that the oil shock risks temporarily derailing the disinflation programme, reviving a fuel tax mechanism to cushion domestic price pass-through.

The energy dependency problem in numbers. Net energy imports represent 3.5–4.5% of Turkey's GDP. A $30 sustained oil price increase adds roughly $15 billion to the annual import bill. Turkey's current account deficit was already $25.2 billion in 2025, before the oil shock. If sustained through year-end, the deficit could approach $35–40 billion — requiring significantly more foreign capital to finance than the country was attracting even before the war.

Scenarios

Conclusion

The lira's depreciation path is not irrational or accidental. It reflects an economy where inflation has structurally run above that of trading partners for years, where a persistent current account deficit requires constant external financing, and where the central bank's independence — while currently intact — carries a credibility discount from the 2021–2023 period that has not fully faded.

The CBRT has been managing the situation competently since 2023, but managing it is not the same as resolving it. The managed depreciation framework works as long as the inflation differential closes gradually, carry trade inflows continue to finance the current account, and the central bank retains political room to hold rates at restrictive levels. The Iran war has put all three of those conditions under stress simultaneously.

The pace at which oil prices normalise, and whether the CBRT has the political cover to respond appropriately if they do not, will largely determine which of the scenarios above plays out. The feedback loops that drove the 2021–2023 crisis have not been dismantled — they have been suppressed by a positive real rate and a credible economic team. Whether that remains true through the current shock is the question the market is pricing right now.

This article is for informational purposes only and does not constitute investment advice. All exchange rate and inflation figures are approximate and sourced from publicly available data as of April 2026.