Time is running out for Erdogan as the Turkish economy is on the verge of a currency crisis that may lead to a full-blown financial crisis. Last week Turkish lira hit the lowest level at 6.88 lira per dollar. Turkish Lira fell 40 per cent since the start of the trade war and 25 per cent in the last two weeks as USA is imposing more tariffs on Turkish goods and sanctions after the arrest of the US priest. Erdogan is blaming everybody except him. He thinks that the dollar, euro and gold are the weapons of financial destructions aim at him to destabilise the economy and the country for not getting along with the west.
The fall of Lira should not come as a surprise as troubles were brewing in the economy for quite some time. Only a decade ago Turkey was the 18th largest economy in the world. As the darling of emerging market economies, it was the favourite destination of international capital and its exports, particularly to its neighboring countries in the region, were booming. But in recent years, its macroeconomic fundamentals weakened considerably and now the economy is going downhill because of misjudged economic policies
An important measure of the health of macroeconomic fundamentals in an economy is the current account-GDP (Gross Domestic Product) ratio. Current account consists of trade balance, net interest earnings and net unilateral transfer payments or receipts such as gifts, foreign aid, etc. A deficit in the current account implies that the country receives less in terms of export earnings, interest income and unilateral transfers from foreign sources than what it pays out to them. The biggest component of the current account deficit is the trade deficit which implies that a country is importing more than what it exports.
The current account deficit of Turkey reached a staggering $49 billion dollar this year. Among the emerging market economies, only India has a higher CA deficit, but India's GDP is three times as high as that of Turkey. Currently this ratio stands at 5.4 per cent, higher than most emerging market nations. The current account deficit implies inflow of foreign capital, mostly of short-term nature to finance the deficit. According to the Economist magazine, the Turkish economy accumulated a foreign debt of $220 billion. Most of the foreign borrowings, undertaken mostly by Turkish banks and private corporations, are denominated in external currencies such as dollar and euro. By providing credit guarantees, Turkish central bank is indirectly responsible for encouraging accumulation of a large foreign currency debt by Turkish financial institutions and banks, according to a recent article published in the Wall Street Journal.
Weakening of lira increases the debt burden of Turkish banks and corporations to an unsustainable level since most of debt are denominated in foreign currency. Imposition of tariff by the USA at a rate of 25 per cent on Turkish steel and aluminum and other US sanctions are hurting the economy. Turkish central bank may not have enough reserves to defend lira, one reason Erdogan is turning to Russia for support.
Government monetary policies are also to blame for the deteriorating currency crisis. According to IIF (International Institute of Finance), a Washington-based think tank, the government-issued debt in foreign currency rose to 11 per cent of GDP recently. Turkish central bank kept interest rate deliberately low, which will not help in preventing its downward spiral and will fuel further inflation in a country, which is already experiencing a double-digit inflation. Among the big emerging market economies, only Argentina and Egypt have double-digit inflation rates.
Turkey used to be a hot spot for short-term portfolio investment or so-called "hot money" by investors who wanted to invest in emerging economies and therefore, Lira is susceptible to a sudden flight of capital out of the country, triggering a contagion that might spread to other emerging economies. Earlier this year, IIF has identified currencies of Argentina and Turkey to be overvalued, which means that currencies are too strong for trade deficits to be corrected on their own. Usually the International Monetary Fund (IMF) advises countries with overvalued currencies to devalue their currencies. If they remain overvalued, they are easy targets for speculative attacks, as market agents believe that they cannot remain at those high levels. The speculative attack on Mexican peso and on Thai baht happened respectively in 1994 and 1997. Over the last few years, Turkey also lost lots of international goodwill. In situations like this, usually IMF comes out to bailout the country as it happened with Mexico in 1994 and other Latin American countries in 1990 and 1994. Given the strained relationship with USA and other EU countries, it is very unlikely that IMF will come to the aid of Turkey.
Syed M. Ahmed, Ph.D is a Lawton Independent Agents Chair and Professor of Economics and Director of Bill Burgess Jr. Business Research Center at Cameron University, Lawton, Oklahoma, USA.