Can Turkey Avoid a Crisis?

Can Turkey Avoid a Crisis?

Last week we introduced to the currently developing financial issues in Turkey. More specifically, their national currency, the Turkish lira, has been crashing hard against the dollar, losing more than 40% of its value in 2018; inflation is soaring high and the Turkish central bank’s hands are somewhat tied by President Erdogan, who would not permit a rate increase. Now that there is more information available, we would like to take another look at whether or not this could escalate out of proportion.

The Problem
Part of the reason we are seeing this unfold now of all times is the strength of the dollar. The Federal Reserve has implemented multiple interest rate increases over the past two years, and there are two more hikes expected in 2018. As people try to capitalize on the higher USD values, this adds pressure on the currencies of developing countries like Turkey (also Argentina, for instance, who is also struggling with a crisis right now).

Moreover, many Turkish businesses have international loans to fund their operations. With the growing gap between the dollar and the lira, these loans are quickly becoming more and more difficult to pay back, simply because they cost so much more in Turkish lira now than they did initially.

Inflation is extremely high in Turkey right now. Under normal circumstances the central bank would increase interest rates (like the Federal Reserve is doing) to curb inflation, but President Erdogan believes that rate hikes are out of the question and has decried them in his political platform. Furthermore, the central bank of each country is supposed to be independent of whoever is in charge and take care of the economy impartially, but Erdogan has done a lot in recent years to solidify his power and become something akin to an absolute monarch, rather than an elected president, at least in practice.

Temporary Solutions
Turkey was in need of a big foreign investment and found it in an unlikely ally – Qatar. Last year Qatar found itself in a tough spot as its neighboring countries all cut diplomatic and trade ties with it. Turkey lent a helping hand then and it seems Qatar is now returning the favor with a $15 billion investment.

Moreover, the Turkish central bank is trying to informally increase interest rates in a way that won’t clash with Erdogan’s official policies. Instead of doing a formal rate hike, the way the Federal Reserve and the Bank of England have done, the Turkish central bank is forcing banks to borrow money at night instead of during the day, and charges them 1.5% more at night. This was effective enough in stabilizing the lira this week, but it is not as strong and sustainable as an actual rate increase.

Investors fear that the measures that Turkey is currently taking are only good for buying a little bit of extra time before a full-blown crisis begins.

If things worsen, Turkey might have to ask for a bailout from the IMF, the way Argentine did. However, like the bailouts given by the ECB to Greece, this would come with a strict plan for austerity measures until the economy heals, and would be seen by the Turkish people as Erdogan’s biggest political failure. This explains why the President is trying to avoid it at all costs.

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