Turkey – Making Sense of the Currency and Economic Crisis 2018

What is wrong with the economy of Turkey?

Turkey, a beautiful nation surrounded by seas on three sides, adopted Presidential system in 2017 and elected Recep Tayyip Erdogan as new President in 2018 to lead the nation. In 2017, Turkey became world’s 13th largest country on the basis of GDP (PPP adjusted) and the Turkish economy rose 7.4% year-on-year in the Q1 2018, becoming one of the fastest growing nation. So what exactly went wrong from there?

History tells that economy and autocrats don’t always get along. The foreign currency debt fueled GDP growth, falling confidence in the domestic democratic institutions, increasing political uncertainties with President Erdogan’s constant intervention in the economic and judicial policies, reduced control of the central bank over the inflation and currency were a few of the wrong issues with Turkey. Recently imposed economic sanctions by the US over the release of an imprisoned pastor in Turkey escalated the currency fueled economic crisis.

The US President Trump’s muscular foreign policy of addressing all global matters with trade tariffs, retaliatory rhetoric by Turkish President Erdogan coupled with the inefficient policies of Turkish central bank have led to free fall in the Turkish currency lira.

Latest Facts about the Economy of Turkey

  • Since the Presidential election of 2018, the Turkish lira has fallen more than 24% till 21st August.
  • Ratings agencies Moody’s and S&P have downgraded Turkey’s credit rating deeper into ‘junk’ status with a ‘negative’ outlook.
  • Inflation rate rose to 15.9% in July 2018 on the back of rising food, beverages, and housing & utilities prices.
  • The current account deficit has risen to ~6% of GDP and net foreign debt rose to 34% of by the end of Q1 2018, infusing instability in lira and foreign exchange reserves
  • The Interest rates are very high with 3 month rate at ~21% and 10 year rate at ~19%. The central bank has raised the rates multiple times in last few months; however the hikes have failed to bring stability in inflation and lira.
  • Investors are also worried about the upcoming (the end of 2018) debt financing obligations of around USD16 billion of the Turkish government.

Turkey needs to be saved?

Turkey, an important country, strategically positioned in the middle of the democratic west (Greece and Bulgaria) and the war-ridden east (Iraq and Syria), also a member of NATO, OECD and G20 nations, physically avoids the wars of Syria and Iraq from progressing to Greece and Europe.

Turkish economy form around 1% of the world economy and global exposure to the Turkish banking sector is not so huge. Economically, Turkey is considered an emerging market (EM) and EM debt funds have exposure to nation’s debt. Any default in the interest payments by the Turkish government will trigger redemptions from these funds, spreading the fear in other emerging markets and widening outflows from EMs to Developed world leading to USD strengthening.

Right now (As on 21st August), the situation has not worsened enough to be called as an emerging markets crisis but it cannot be ruled out. Worryingly enough, European banks have started the process of limiting their exposure to Turkish debt markets.

Obviously President Erdogan’s policies and excessive controlling over the central bank has rattled the investors. With the difficulty in refinancing the debt due to latest US sanctions and falling government support, various firms have been filing for bankruptcy, stock market has fallen to the lowest level in USD terms since the global financial crisis in 2008, consumer confidence falling sharply and silly comments by President and his team have made things worse for Turkey.

A report from the Bank for International Settlements estimated that banks from Spain and France have maximum exposure to Turkish debt, USD83 billion and USD35 billion, respectively.

Wake up Turkey – Ask for support!

Remember, in 2014, when Russian ruble fell significantly, the Russian central bank raised interest rates by 6.5% and eased liquidity for the banking system through many other measures. It is quite clear that the central bank’s interventions to save the falling lira and monetary policies to control inflation are not paying off. Surprisingly, the central decided to leave the interest rate unchanged at 17.75% in its recent meeting, clearing indicating that President Erdogan has increased his influence over the central bank.

Turkish government is looking out for new friends to bail it out and the search is taking longer than ever. Qatar, an all-weather ally of Turkey has offered to invest USD15 billion while Germany has also shown support. It is positive but the aid is too small compared to Turkey’s current account deficit and pressing cash needs. Germany has not offered any money, as of now.

Erdogan is the only one to blame?

President Erdogan is trying his fortune against US President Trump and his muscular trade-based foreign policy. Turkey has managed to anger Trump by not releasing the American pastor and buying missile from Russia. Trump put the final nail in the coffin by doubling tariffs on imported Turkish steel and aluminium, hurting Turkey where it hurts the most.

Read: Making Sense of the Strength in US dollar

Diplomacy is the best answer to Turkey’s problems. Turkey can put immediate pressure on the US and European leader by quitting NATO and join Russia, Iran and Syria in showing the world that the US is a bully. President Erdogan can also force the migrants, coming from Syria and other war-ridden nations to Europe, creating a crisis like situation. President Erdogan can force the US to dump the recently imposed sanctions though these diplomatic moves. Also, both Turkey and the US can agree on the trial of the American pastor in any neutral international court over the charges of instigating the 2016 coup attempt.

Economically, it seems that President Erdogan’s polices have failed miserably in the current global context. Turkish central bank needs to come out of the shadow of President Erdogan and increase the interest rates to support the falling currency and seek IMF’s help for repayment of upcoming debt obligations. It is certainly not in the best interest of anyone to see Turkey trapped in the economic crisis and what if the last borders of Europe to the war ridden Syria falls in the hands of radicals, God save us.

Investors are looking for both diplomatic and economic solutions of Turkey’s problems. Hope the sanity prevails.

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