After recent elections, the biggest challenge for the Turkish government was stabilizing the worrisome economy. But poor U.S.-Turkey relations and investor uncertainty about Turkey's ability to stabilize its volatile economy have pushed its currency, the lira, to an all-time low. Its crash is pressing on the country's dollar-denominated debt and raising questions about whether President Recep Tayyip Erdogan will temper his political moves to allow room for economic stabilization.
What Happened?
Turkish President Recep Tayyip Erdogan spoke before the nation twice on Aug. 10, but the country's currency continued its descent, reaching about 6.4 lire per dollar, a decline of about 14.6 percent. At one point during the day, it had fallen more than 20 percent. Meanwhile, new Treasury and Finance Minister Berat Albayrak, also the president's son-in-law, previewed a new economic program for the country. The president — instead of reassuring the markets, whose collapsing confidence is one of the main drivers behind the lira's unprecedented depreciation — slammed Western countries and accused them of waging economic warfare on Turkey. He returned to his familiar refrain of urging Turks to use their reserves of dollars, euros and gold to buy up lire. The markets reacted swiftly, and the lira dropped even further.
What Are the Government's Options?
Erdogan won re-election in June and has secured an empowered presidency, leaving him freer to confront the country's economic challenges. Municipal elections are not until April 2019. But the question is whether Erdogan has the political will, and the ideological inclination, to change course.
The government has political and economic options at its disposal to try to calm the currency's volatility, to keep inflation — now about 15 percent but climbing — under control and to reassure investors. The economic options include a central bank intervention by raising interest rates, although this would have a temporary effect, and Erdogan is famously hesitant to raise rates. (The last substantial hike was in January 2018; before then, it was in late 2013, when Turkey was dealing with the end of the U.S. Federal Reserve's quantitative easing program.) The country could also place controls on capital, but those can hamper private sector activity and won't be easy considering the government's relative inability to totally control private capital.
Politically, Turkey's finance minister continues to try to say the right things, including that the country will embrace a tightened fiscal policy in the coming months to achieve the strategic goal of "economic balance." He has also promised to narrow Turkey's current account deficit. But Erdogan has consistently sandwiched every moderate statement by his son-in-law with nationalist and populist rhetoric that only undermines investor confidence. The president, after all, chose a family member to head this influential position for a reason. The prospects for Albayrak being able to pursue an independent economic policy to safeguard the autonomy of the Central bank do not appear good.
Will Diplomatic Tensions Heighten the Currency Challenge?
The United States and Turkey are already at loggerheads over trade, defense deals, the future of the U.S. mission in Syria and Ankara's warming ties with Russia. On the morning of Aug. 10, U.S. President Donald Trump intensified these divisions by tweeting that he had authorized a doubling of tariffs on Turkey's steel and aluminum, rising to 20 percent on aluminum and 50 percent on steel.
Erdogan's nationalist campaign and Trump's "America First" policy clash perfectly. Trump's public announcement of tariffs will only fan Erdogan's economic warfare narrative, which puts the source of Turkey's economic woes outside its borders. Furthermore, consternation in the U.S. Congress has led to a nascent bill that could limit Turkey's ability to obtain loans from any U.S.-based financial institutions.
And some Turkish banks are already under U.S. scrutiny for transactions with Iran. With new Iran sanctions coming up, more Turkish banks could face U.S. probing if they are doing business with the Islamic republic.
Is a Bailout Coming?
While the International Monetary Fund has a history of lending a hand to Turkey, Erdogan is wary of the organization, creating barriers to a bailout. An IMF offer will come with strings attached — strings that Erdogan may find a violation of sovereignty — including demands to rein in the country's runaway inflation with higher interest rates. That move would collide with Erdogan's beliefs that see him consistently slamming interest rate hikes.
Another option is aid from other countries — possibly Qatar or China, an ally in the BRICS group. For China, stabilizing a fellow emerging economy's currency has value, but Beijing could also benefit from becoming an economic friend to a NATO state whose relationship with the West is increasingly strained. Erdogan could also entertain help from Qatar, but the benefits of such aid from Doha would be limited.
Is There a Contagion in the Air?
Turkey is a major emerging market economy with $466 billion in foreign debt (about 78 percent in U.S. dollars and about 18 percent in euros), or 52.9 percent of gross domestic product. And more than one-third of that debt is coming due within the year. These looming payments are one of the main reasons for the government's fragility, because a weaker lira makes that debt more expensive to pay off. This situation has led the European Central Bank to sound alarm bells warning that Turkey's currency problems could infect Europe's banks. The central bank noted that Spain's BBVA, Italy's UniCredit and France's BNP Paribas all have significant exposure to Turkish debt and that a crashing lira could affect repayment of foreign currency loans. Spanish banks, in particular, are the most exposed, with over $80 billion in Turkish loans.
The lira's plummeting value, the potential for debt defaults, the possibility of a balance-of-payments crisis and rising inflation all represent clouds gathering ahead of an economic storm that could batter the country. In addition, there is little confidence that the government will pursue a policy that will ease the downturn.
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