Last Friday, the Turkish lira lost close to seven per cent of its value in a single day of trading, closing in at 6.43 against the dollar. This unprecedented fall was triggered primarily by President Trump’s tweet signalling a doubling of US tariffs on Turkish exported steel and aluminium, which came as the latest event in a series of deteriorating relations between Ankara and Washington.
At close to $8.6 billion, the United States is Turkey’s fifth largest export market, close to $7bn of which is made up of steel and aluminium products. The crisis in a $7bn export market for a country that sells goods worth $157bn to the world should not cause such an extraordinary fall in its currency.
But the truth is that regardless of Ankara’s recent spite with Washington, the lira was set for a fall: in 2018 alone, it lost almost 35pc of its value. While some of this may have been caused by the recent hike in interest rates in developed economies, a large part of Turkey’s currency deterioration is a reflection of President Tayyip Erdogan’s preference for populism at the expense of economic logic.
It is yet another story of the temptation of debt-fuelled economic prosperity, and the denial that it begets.
Turkey’s economy consistently posted stellar growth numbers following the financial meltdown of 2008: annual gross domestic product (GDP) growth in the past decade hovered around the 6-7pc mark, and even went up to 11pc in the latter half of 2017.
Turkey’s currency weakness is a reflection of President Erdogan’s preference for populism at the expense of economic logic
These growth numbers were a function of high consumer and government spending, fuelled by relatively low-to-modest borrowing rates. A consistent growth in demand — and consequently supply — in the absence of corresponding adjustments in the policy rate led to an overheating of the economy. Many economists warned of a complete meltdown if interest rates were not raised. Side by side, the private sector accumulated large amounts of both domestic and foreign debt, motivated largely by cheap interest rates. The Turkish economy had slowly but surely become a dangerous pressure cooker. The central bank seemed reluctant to let out the accumulated steam by raising interest rates to curb inflation.
Since January 2017, the consumer price index has remained above the 10pc mark and peaked at 15pc last month; policy rate hikes from the central bank during this time have been either untimely or insufficient — and most frequently, both.
This has called into question the independence of the central bank, which seems to be under the control of President Erdogan, who wants to wage a “holy war” against interest rates that he believes are the “mother and father of all evil”.
And now, an economy with large public and private debt holdings is on the verge of a serious economic crisis — a crisis that will cause problems not just for Turkey, but possibly for global investors and emerging markets.
The total stock of foreign debt accumulated by the government over the years stands at $453bn (more than half of the country’s GDP) while the stock of domestic debt stands at approximately 954bn liras (30pc of GDP). While these huge stocks of debt were part of the problem leading to Turkey’s current economic situation, they will now reach unprecedented levels following the fall in the lira’s value.
Even more worrisome is the plausible likelihood of a bigger banking crisis that could engulf not just emerging markets but also much of the eurozone. Large Spanish banks are owed more than $82bn while French banks have $38bn in loans outstanding, according to the Bank for International Settlements in Basel, Switzerland.
The response from President Erdogan has been characteristically populist (and based in fantasy). Blaming the crisis on “economic terrorists”, the president has given few solutions other than telling Turkish citizens to sell any private holdings of foreign currencies and precious metals to help the lira from drowning further.
Limited relief has come from the central bank of Turkey, which has suggested a relaxation in its reserve requirement to increase liquidity to avoid a run on Turkish banks. The move will free up 10bn liras ($6bn) and $3bn of gold liquidity in the financial system, the bank said. However, the central bank has not raised interest rates, which many argue is necessary to alleviate the crisis and curb inflation along with providing a deterrent to investors from selling the lira.
Turkish Finance Minister Berat Albayrak, who is the president’s son-in-law, rejected capital controls as an option to stem outflows of hard currency.
Turkey’s economic problems require a return to monetary economic fundamentals and a plan to considerably reduce its stock of debt. Its economic leadership must learn from the mistakes committed by other countries in the past. A prime example is that of the US Federal Reserve in the 1970s that kept interest rates low. The Fed chairs at the time were businessmen and had a preference for low interest rates. The result was a 10-year period characterised by high inflation and repeated recessions.
The writer works as an economist at an Islamabad-based think tank.
Published in Dawn, The Business and Finance Weekly, August 20th, 2018