Even though our usual topics – trade wars, Brexit, oil volatility – continue to dominate the financial markets news feeds, this week we want to turn your attention to a slightly overlooked development: Turkey. Nestled between the European Union and the Middle East, the country’s economy is worth $860 billion but now Turkey finds itself on the verge of a major financial crisis. What happened?
The short answer to that question would hardly surprise anyone: political problems. For about 15 years Turkey has been ruled by Recep Erdogan, who began his term as President with favorable reforms, expanding the economy, and attracting much foreign investment. However, in 2016 there was an unsuccessful military coup against his rule, and since then Erdogan’s political tone shifted to a much more conservative, even authoritarian approach, with massive arrests against his opposition, a shutdown of media critical of his rule, and so on. Moreover, Turkey is still engaged in a conflict with ethnic Kurdish people who have claimed their own state between Turkey, Syria, and Iraq. These factors have led the international community to view the political landscape in Turkey as a source of risk and uncertainty.
From a financial standpoint, from 2016 Erdogan ordered banks to give out more loans in order to boost spending, while at the same time lowering interest rates, which made loans more appealing to the Turkish population. However, unchecked inflation can always lead to trouble: in this case, right now the inflation rate in Turkey stands at nearly 16%, way over the desired 2% that developed countries like the United States and the EU strive for.
Because of the high inflation, the Turkish currency, the lira, has been in major trouble all throughout 2018. Since the beginning of the year the lira has shed 35% of its value compared to the American dollar. This is due to the tension between Turkey and the United States, as the US announced a round of tariffs for Turkish imports earlier this week.
The United States took aim at Turkey, which previously had a duty-free trading relationship with America, because an American citizen was arrested on President Erdogan’s authority and stands accused of participating in the previously mentioned 2016 coup. Turkish representatives are expected in the US to begin negotiations to lift the newly imposed duties.
The woes of the lira are also spreading to the nearby European markets. Major European banks such as UniCredit and BNP Paribas are active in Turkey, so the ECB is worried that problems within the country can cause financial trouble for these banks even outside of Turkey. Their stocks dropped by roughly 4%. Because of the presence of European lenders in Turkey, the ECB is concerned that the eurozone finances might be affected.
Currently the finances of Turkey are not great. Banks have been lending too much and do not have sufficient reserves to guarantee safety. The country has a shortage of US dollars because they prefer to invest in gold instead. This is also bad news, because gold has been dropping in value all year. In other words, to deal with this problem Erdogan must either allow banks to raise interest rates to curb inflation, or he has to ask for help from the International Monetary Fund. So far he has shown an unwillingness to do either of these things. Right now the Turkish President seems far more concerned with making populist statements consistent with his image than actually preventing the further slump of the Turkish lira, which might cause the next big financial crisis – and soon.