U.S. sanctions on NATO-ally Turkey might deter future arms deals with the likes of Moscow, but it could also play into Russian President Vladimir Putin's hands, analysts have told CNBC.
Turkish dollar-denominated bonds and the lira have both fallen in recent days amid economic and geopolitical turmoil for Turkey, with investors concerned about its credibility and the potential for U.S. sanctions over a Russian weapons deal.
President Recep Tayyip Erdogan sacked the country's central bank governor earlier this month, prompting fresh criticism regarding the institution's independence and leading ratings agency Fitch to downgrade Turkey's investment rating to "BB-."
But looking ahead, market watchers are now worried about the American response to what continues to be a significant headache for NATO: Ankara has officially begun receiving parts for the Russian S-400 air defense missile system, the result of a weapons deal that Washington has long lobbied hard against.
Senators are now urging President Donald Trump to slap sanctions on Turkey. Erdogan "has chosen a perilous partnership with (Putin) at the expense of Turkey's security, economic prosperity and the integrity of the NATO alliance," four senators, including chairmen of the Senate Armed Services Committee and the Senate Foreign Relations Committee, said in a bipartisan statement last week.
Trump, by contrast, has been far less confrontational on the issue.
U.S. officials see the deal as a threat to NATO, for which Turkey provides the second-largest military. And according to Pentagon officials, it's a security risk to the American-made F-35 stealth fighter jets — 116 of which have been sold to Turkey — as allowing the S-400 and F-35s to operate near one another could allow for Russian intelligence gathering on the American system.
Sanctions, the senators hope, would send a clear message about NATO members buying weapons from non-NATO countries, particularly those considered adversaries of the 70-year-old alliance.
"Turkey's purchase of S-400s undermines efforts to coordinate arms production/procurement within NATO — and the risk now is that other countries follow Turkey's lead, buying major arms systems from non-NATO countries," Timothy Ash, emerging markets strategist at Bluebay Asset Management, said in an email. "Perhaps more importantly for the U.S. defense industry, the green light has been given for NATO members to buy kit from rival countries, Russia and China, in particular."
"This is surely a huge risk to the U.S. defense industry."
Proponents of sanctions also fear that not responding in this instance could weaken Washington's broader sanctions tools that are being used in other countries like Venezuela, Cuba, North Korea and Russia.
While attempting to deter future NATO member arms deals with the likes of Russia, U.S. sanctions on Turkey could ultimately benefit Putin, some analysts say.
"Sanctions will just push Turkey further out of the Western orbit and further into the hands of the West's enemies, Russia, Iran, et al," Ash said. Fractures within NATO have long been a goal of the Russian president.
Turkey could respond to sanctions by restricting U.S. access to its Incirlik air base, a strategically vital launchpad for American operations in the Middle East. It could also escalate attacks on U.S.-backed Kurdish militias in Syria, where the two have long been at loggerheads over the armed groups that each country supports.
For Ali Bakeer, an Ankara-based political analyst, sanctions are the wrong move.
"I think Russia outsmarted U.S. in the last few years when it comes to attracting Turkey toward it," Bakeer told CNBC. "It would be a big mistake to help Moscow achieve its goals of widening the gap between the U.S. and Turkey and create a rift within NATO by imposing sanctions on Ankara."
Under CAATSA, the Countering America's Adversaries Through Sanctions Act, the Trump administration must pick at least five out of 12 designated measures against Turkey including sanctions on its exports, arms, financial institutions and loans from U.S. banks.
Some regional experts believe sanctions would likely fall on military-related companies, which they say wouldn't take a massive toll on Turkey's economy. But if they hit banks, Turkey's sovereign rating and its lira currency could suffer further.
Any sanctions would likely rattle economic and investor confidence in the country of 80 million, especially after more than a year of financial turmoil due to previous diplomatic spats with the U.S. and a host of unorthodox policy decisions by Erdogan. The lira lost nearly 30% of its value against the dollar last year amid sanctions threats from the U.S., skyrocketing inflation and a massive current account deficit, among other issues.
The Pentagon also said in June that it would pull Turkey from the F-35 program, which included Turkish companies' involvement in the maintenance and building of the jets, if it went through with the S-400 purchase.
If this happened or if sanctions hit Turkey's defense industry, "Ankara would suffer and there will be severe damage to the Turkish economy and to Turkey-U.S. relations which will probably result in pushing Turkey more towards Russia," Bakeer said.
Amid Turkey's tense geopolitical climate, some country experts believe sanctions and a further ratings downgrade for the country are on the horizon. But Erdogan on Sunday insisted that Trump could waive any potential sanctions, suggesting confidence that he may be able to pull off the Russian deal after all.