Crisis in Turkey – Lira Exchange Rate Falls by 30 Percent

Events in the financial markets in Turkey are alarming – the Turkish lira has fallen by 30 percent, the stock market has dropped by 17 percent, and interest rates on government borrowing in lira have surged to 18 percent – this could signal an economic slowdown in the country, possibly even a recession, analyzes BBC.

The exchange rate of the Turkish lira has plummeted by 30 percent against the US dollar since the beginning of the year. The stock market has fallen by 17 percent, and when measured in dollars, as foreign investors do, the decline in stock prices has reached 40 percent.

Another metric that is often observed in the markets is the cost of government borrowing. A 10-year loan in lira now costs 18 percent annually, and even borrowing in dollars is expensive, with loans being offered at an interest rate of around 7 percent.

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Turkey is also recording a deficit in international trade. It imports more than it exports, or, in other words, it spends more than it earns. Such a deficit needs to be financed either through foreign investments or borrowing.

This in itself is not unusual or dangerous. However, Turkey’s deficit is quite large, amounting to 5.5 percent of gross domestic product (GDP) last year. There are also two significant features of Turkey’s external debt that increase vulnerability. First, Turkey has a high level of debt that it must repay in the near future, or refinance.

The credit rating agency Fitch estimates that Turkey has financing needs of nearly 230 billion dollars this year.

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Second, many Turkish companies have borrowed in foreign currencies. Such loans become more expensive to repay if the exchange rate of the national currency falls, and it has fallen. A weak currency also exacerbates the inflation problem that persists in Turkey. A weaker lira makes imports much more expensive.

The central bank aims for an inflation rate of 5 percent. A year ago, inflation was significantly above that, around 10 percent. Since then, the situation has worsened further, with prices now rising at an annual rate of about 15 percent.

Investors Disturbed

Investors in the financial market are also disturbed by the views of Turkish President Recep Tayyip Erdoğan on economic policy and the pressure he exerts on the Turkish central bank. It is evident that there is a political option in the central bank that wants to lower inflation by raising interest rates.

Such an action can curb inflation in two ways. It can weaken demand in the country and increase financial returns, which encourages investors to buy lira – this would strengthen the currency and reduce import costs.

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The Turkish central bank has already taken a few such steps, but without any lasting impact on the problem. What troubles the markets is, as most economists would say, President Erdoğan’s poor understanding of interest rates. He has described himself as an enemy of interest rates.

The result is that investors are not convinced that the central bank will do what is necessary to stabilize the currency and thus bring inflation under control. On the other hand, this makes them much more cautious regarding the outlook for Turkish financial assets.

Fitch: Sharp Landing of the Economy Threatened

In some respects, the recent performance of the Turkish economy appears reasonable. The economy has grown every year except for 2001, which was the last year of the economic crisis when they received IMF assistance, and 2009, under the influence of the global financial crisis. In some years, growth has been exceptionally strong.

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Unemployment is high but relatively stable, with a rate of 9.9 percent. The credit rating agency Moody’s points out that Turkish economic growth has reached unsustainable levels due to tax and consumption policies, noting that policies for long-term growth have been neglected due to a focus on electoral cycles.

The Fitch agency, on the other hand, warns that there is an increased risk of a sharp landing for the Turkish economy, which means a sudden slowdown in growth, and possibly even a recession.