News ID: 219629
Published: 0708 GMT August 10, 2018

Is Turkey heading for an economic crisis?

Is Turkey heading for an economic crisis?
EPA

Recent developments in the country's financial markets have certainly been alarming.

The Turkish currency, the lira, has lost about 30 percent of its value against the US dollar since the New Year, according to BBC.

The stock market has fallen 17 percent, or if you measure it in dollars as some foreign investors would do, the decline is 40 percent

Another measure often watched in the markets is government borrowing costs.

Borrowing for 10 years in its own currency now costs 18 percent a year. Even borrowing in dollars is expensive for Turkey at a cost of around seven percent.

 

So what is going on?

Debt dangers

 

Turkey has a deficit in its international trade. It imports more than it exports. Or to put it another way, it spends more than it earns. That deficit has to be financed, either by foreign investment or by borrowing.

In itself that is neither unusual nor dangerous. But Turkey's deficit is quite large at 5.5 percent of national income, or GDP, last year.

There are two features of Turkey's foreign debt that also increase its vulnerability.

First, it has a high level of debt due for repayment in the near future — loans that have to be repaid and the money borrowed anew. To use the language of the financial markets, the debt has to be refinanced. Credit rating agency Fitch estimates that Turkey's total financing needs this year will be almost $230 billion.

Second, many Turkish companies have borrowed in foreign currency. Those loans become more expensive to repay if the value of the national currency declines — which it has.

The currency weakness also aggravates Turkey's persistent inflation problem. The weaker lira makes imports more expensive.

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

Financial market investors are also very uneasy about President Erdogan's views on economic policy and the pressure he is seen as exerting on the country's central bank.

There is an obvious policy option open to a central bank that wants to bear down on inflation — raising interest rates.

That can curb inflation in two ways. It can weaken demand at home, and by increasing financial returns in Turkey encourage investors to buy lira — which strengthens the currency and reduces the cost of imports.

Turkey's central bank has taken several such moves, but without any lasting impact on the problem.

 

US relations

 

What bothers the markets is the president's well known — and most economists would say, ill-informed — opposition to higher rates. He has described himself as the enemy of interest rates.

The result is that investors are not convinced that the central bank will do what is needed to stabilize the currency and bring inflation under control. In turn, that makes them more wary about the outlook for Turkish financial assets.

Confidence has been further undermined by Turkey's strained relations with the United States.

Turkey has detained an American evangelical pastor and there are differences over the approach to Syria. In addition, the US is reviewing Turkey's eligibility for a program that gives many exports from developing countries duty-free access to the US market.

Turkey is also at risk from developments in the US. The Federal Reserve continues to raise interest rates, which encourages investors to pull money out of emerging markets. The impact has been moderate, but it is potential aggravating factor for countries such as Turkey with other vulnerabilities.

   
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