The Turkish lira lost almost half of its value since the beginning of the year, hitting a record low this week. While the growing political disagreement between the US and Turkey is certainly having significant economic implications, only a deeper analysis can explain the root cause of this depreciation, which is shaking markets all over the world.
Recently, the exacerbated tension between the two NATO allies has drawn much attention. On the one hand, Turkey and the US have started a dispute over the release of Andrew Brunson, an American Pastor detained for nearly two years by Turkish authorities who claim that he had links with the banned Kurdistan Workers Party. On the other hand, Turkey’s strong disagreement over the US strategy in Syria, where the US are supporting Kurdish groups in the fight against the Islamic State, is deteriorating the relationship. The situation is causing the two countries to grow apart: Turkey said to be looking for new allies and both sides have translated their disagreement into commercial tariffs, which risks dragging the economy down even more.
These disputes, which are causing US-Turkey relations to deteriorate, only constitute the trigger of this crisis. The reasons for the ongoing troubles are to be found in a set of interconnected elements preceding this period of time.
In the direct aftermath of the Great Recession, many governments have increased liquidity through quantitative easing programs, i.e. programs in which central banks grant cheap loans to commercial banks to inject money in the economy and encourage recovery. After the stabilization of these economies, investors searched for more return on their investments. This is when they found emerging markets: more risk and thus more return on investments when successful. The investments helped emerging markets such as Turkey to flourish after the recession but kept them very susceptible to foreign investors’ moves.
Such instability was worsened by Turkish President Recep Tayyipp Erdogan’s political and economic policies. The President managed to concentrate power in his hands, promoting an authoritarian shift in the country. He gradually banned free media and the political opposition, and obtained decisive influence over the Central Bank which kept interest rate low despite the high inflation.
Erdogan’s economic and political moves caused the trust in the Turkish system to fade. The growing political disagreement with the US and the increasing authoritarianism of the Turkish regime have raised investors’ concerns, encouraging them to withdraw money from the country. Since the system highly depends on foreign investors, these divestments caused the Turkish currency to depreciate.
On top of this, in the last years, the US Federal Reserve decided to stop quantitative easing and increased interest rates gradually. This sent an optimistic message about the good performance of the US economy. As a result, the value of the US dollar increased, causing an even higher depreciation of the Turkish lira. Emerging countries’ governments, investors, and companies that previously borrowed large sums of money saw the value of their debts skyrocket due to the currency appreciation and saw their interests rise due to the increased perceived risk by investors.
Potential worldwide consequences
Why should people, companies, and banks outside of Turkey worry? There are two reasons why the crisis is causing markets all over the world to shake.
First, several banks outside Turkey have lent money to Turkish companies and investors, and to the Turkish government. If the value of the lira keeps decreasing, there will be a large amount of non-performing loans which would cause significant losses for these banks (some of them are located in Europe, such as UniCredit in Italy and BNP Paribas in France) and thus have an impact on other financial systems. European banks control large shares of some of the main Turkish banks. Since non-performing loans are what dragged the Eurozone down before, some worry that this can happen again. Although analysts see the situation as manageable, the ghost of what happened before still scares European economies, especially Italy as the country is expected to make key decisions over its budget and credit ratings after the summer.
Second, Turkey was only one of the several emerging markets which attracted foreign investors like a magnet. The Turkish precedent might decrease investors’ trust in other emerging economies and turn this into a self-fulfilling prophecy. In other words, scared that something similar could happen elsewhere, investors might divest their capitals from other emerging economies causing a depreciation of other currencies and triggering a domino effect.
The lack of structural reforms
In line with its political strategy, Turkey has searched for help in new allies. In the last days, Qatar has pledged to invest 15 billion dollars in the Turkish economy. Simultaneously, the value of the lira has started to rise as Turkish authorities try to calm investors. However, the previous days show that Turkey’s economy needs structural reforms to recover. The government isn’t likely to adopt reforms because Erdogan will continue to maintain a strict authoritarian regime where corruption and cronyism serve his circle’s interests, especially since the Turkish President suppressed free media and political opponents and is currently surrounded by advisors who validate his views and won’t break the circle. In a situation like this, where politics influences the market so negatively, Qatar’s billions – or any other country’s investments – cannot save the lira.
Author: Ljuba Ferrario