Why the lira went into freefall

 

The Turkish lira has lost more than 45 percent against the dollar since the beginning of the year. Initially the reasons were manifold and interlinked: A sizeable current account deficit, the government’s undue influence over the central bank, its opposition to hiking interest rates, high inflation, geopolitical tensions and other factors.

Markets were skeptical when President Recep Tayyip Erdogan last month appointed his son-in-law Berat Albayrak as finance minister, replacing the seasoned ex-banker Mehmet Simsek. There were some wobbles but things steadied, before all hell broke loose and the lira went into freefall.

This was exacerbated by mounting tensions between the US and Turkey. President Donald Trump doubled tariffs on steel and aluminum and imposed sanctions on some government members after Erdogan refused to release detained US evangelical priest Andrew Brunson. Things did not even calm down after a news conference by Albayrak, where he put forward a plan to combat the country’s economic woes. The lira continued its downward slide.

This all helped boost Turkey’s already high inflation rate. The country’s economy depends on importing energy and essential goods; the impact of the lira slide has also been felt in Turkey’s corporate sector, where companies have widely borrowed in foreign currency.

Over the weekend we saw signs of contagion. The Russian ruble, the Indonesian rupiah and the South African rand depreciated heavily. The euro lost against the yen, which makes sense because Spanish, French and Italian banks are exposed to Turkey. The Turkish crisis will not be Greece 2.0 as far as the euro zone is concerned. However, banks BBVA, UniCredit and BNP Paribas all have exposure to Turkey.

To stabilize the situation, Turkey will need to address the crisis by restructuring foreign currency debt, fiscal tightening and probably by hiking interest rates, even if the government balks at the idea.

Cornelia Meyer

The levels of exposure vary. According to the Bank for International Settlements, Spanish banks have $82 billion in exposure to the Turkish economy, while the German banking sector’s exposure is limited to $17 billion. In the GCC, we see Qatari banks — mainly QNB — and Kuwaiti lenders with some, all be it limited, exposure to Turkey.

The question for Turkey is where to go from here. Early Monday morning the central bank lowered the reserve requirements for banks, which gave some temporary respite. To stabilize the situation, Turkey will need to address the crisis by restructuring foreign currency debt, fiscal tightening and probably by hiking interest rates, even if the government balks at the idea. Some observers have suggested an interest rate rise of 1,000 basis points, which would certainly be politically difficult. The issue for the government is to get ahead of the story and do something which is bold enough to turn the ship around. Small incremental moves will not do the trick. Turkey will try to avoid involving the International Monetary Fund, because its measures would be seen by the government as infringing on Turkish sovereignty.

Some commentators are rather more upbeat on Turkey’s economic outlook than you might imagine. Murat Yulek, renowned author and CEO of Turkish consultancy PGlobal, said: “The fundamentals in the Turkish economy are still good and once markets have seen the right steps by the central bank, the crisis will abate and the currency will trade in line with fundamentals.”

That said, the short-term outlook is dicey and measures will have to be taken to avert a meltdown. Geopolitical tensions with the US are not helpful. Over the weekend, Erdogan put pen to paper for an op-ed in The New York Times, in which he stressed how important Turkey was to NATO but that he had the option to look elsewhere for new friends and allies. The inference was that he would look east to nations such as Russia and China.

The rhetoric on both sides needs to cool down however, because Turkey is geopolitically very important to both Europe and NATO. It is also economically close to Europe, which is why nobody has an interest in seeing the economic situation deteriorate any further.

As far as contagion is concerned, we should worry less about what this crisis does to emerging-market currencies, because the effect of the lira depreciation is temporary and the Turkish economy is still relatively small. The growth engines of the global economy — namely the US, China, Japan and Europe — are still in relatively good shape. We should, however, watch closely what impact the planned rate rises by the US Federal Reserve Bank will have on emerging-market currencies — particularly in countries with large current-account deficits such as Turkey and Indonesia.

 

  • Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources

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