Question

What do you think was the impact of Turkey’s currency crisis on Turkey? What measures has been taken to stabilize the lira? Did the measures fail or succeed? What would you expect to happen to the value of the Turkish lira? (2 page-5 pages per essay + citation page)

Answer 1

The Turkish economy contracted 3.0 percent year-on-year in the fourth quarter of 2018, after a currency crisis knocked some 30 percent off the value of the lira last year. Economists expect two more quarters of contraction year-on-year.

The lira has lost as much as 15 percent against the dollar this year, with the latest weakness driven by investor concerns over Monday’s decision to re-run a mayoral election in Istanbul that had been narrowly won by the main opposition party.

Turkey’s central bank moved to tighten policy by funding the market through a higher rate and took additional liquidity steps, while state banks sold dollars to boost the local currency.

Turkish inflation and employment will improve this year, while the government will implement necessary reforms without hesitation.

Turkey’s growth has been virtually keeping pace with that of China and India but it is now displaying the classic signs of overheating: a large trade deficit, a construction boom and soaring debt. Financial markets have taken fright at inflation, rising at an annual rate of more than 15%, and have been selling the Turkish lira, which is down by 45% against the US dollar since the start of the year.

The direct impact of what looks like an inevitable recession in Turkey would be relatively small because, despite a population of 80 million and strong growth in recent years, the country accounts for only 1% of global GDP. Eurozone countries run a trade surplus with Turkey but it is small. In the two previous Turkish financial crises since the turn of the millennium, European exporters have been able to divert their business to other markets. The European Central Bank has expressed concern about potential contagion through the eurozone banking system, with Spain, followed by Italy, the most heavily exposed countries.

A bigger danger is that Turkey’s crisis will spill over into other emerging market economies and there were signs on Monday that other countries seen as vulnerable were coming under speculative attack. Turkey’s problems are particularly acute because it has more than $300bn of dollar-denominated corporate debt, which is getting more expensive to finance by the day. However, other countries – such as Mexico and South Africa - also took advantage of low US interest rates in the years after the financial crisis to borrow heavily in dollars and saw their currencies coming under pressure. The fear is of a full-blown emerging market crisis.

As part of the expansive measures, the banking watchdog, the Banking Regulation and Supervision Agency (BDDK), decreased the daily limit on foreign currency swap transactions from 50 percent of banks' equity capital to 25 percent. Withholding tax on deposit accounts has been regulated, and business contracts inked in foreign currencies have been converted into Turkish lira. The treasury and finance minister strongly emphasized that the recent measures have received a strong response from international investors. "Thanks to a strategic debt policy, we have decreased the sensitivity of the debt stock to interest rates, exchange rates and liquidity risks

1. Rate hikes

“The policy response needs to be a further hike in policy rates, more than 500 basis points, fiscal tightening of 1% to 2%, and measures to address concerns over bad debts in banks in sectors such as energy, real estate and construction

2. Currency fix

Turkey should peg the lira and adopt a currency board, a move which would force Ankara to effectively give up its discretionary monetary policy.

This would help to stabilize the currency and let Turkey rebuild its credibility in financial markets.