Closely watch Turkish currency crisis … Lira meltdown can put Eurozone economies at risk (Current Issue No. 2923)

        In 2018, the Turkish economy is facing pressures from all sides amid risks threatening its economic stability such as the Federal Reserve interest rate hike, which accelerates fund outflows and continuously and quickly increases borrowing costs. An increasing oil price and weaker Turkish lira have caused Turkish inflation to surge.  This latest crisis was triggered by intensified political tensions between the US and Turkey. Due to an anticipation of Washington’s harsh trade protective measures against Istanbul, investors have seemed to lose confidence in the Turkish economy, triggering the currency freefall.

        The Turkish economy is facing challenges on all fronts, particularly the question over its stability.  Turkey’s current account deficit rose to almost 6.0 percent of the country’s Gross Domestic Product (GDP).  Turkey imported a large quantity of capital goods for export-oriented production and a large amount of oil. Therefore, Turkey’s current account deficit continued to widen significantly, especially when oil prices were rising. The Turkish economy heavily relies on foreign funding with gross external debt reaching USD470 billion or 53.7 percent of GDP, and more than 40 percent of the debt borrowed by Turkish private sector is in foreign currencies.  In addition, the country’s financial costs rose dramatically and excessively partly because of skyrocketing inflation and capital outflows. Turkey’s central bank raised the policy rate from 8.0 percent registered in early 2018 to 17.75 percent on June 7, 2018, causing the 10-year bond yield to almost double from 11 percent early this year to almost 22 percent, currently. In the meantime, Turkey does not have many tools left to stabilize its economy because the country’s foreign currency reserves plunged to only USD130 billion as compared to USD120 billion of Turkey’s short-term external debt or almost 100 percent of its currency reserves. Therefore, the Turkish government does not have much room to maneuver to stabilize the lira. 

 ​Although the currency crisis has been eased somewhat, the question over its stability lingers. It is imperative for the Turkish government to fix the fundamental problem, namely, a large current account deficit and excessively high inflation.  Turkey’s central bank is likely to raise the interest rate further.  Although the rate hike may harm Turkish economic growth, the measure should earn more confidence from investors more than market intervention measures such as capital movement controls. If the lira crisis leads to an economic crisis, it may spread to the global financial market, especially the banking sector in Europe because the banking sectors in Europe and Turkey are intertwined. Close attention must be paid to how the lira problem will evolve.