Turkish Currency and Debt Crisis of 2018

The Turkish currency and debt crisis of 2018 is an ongoing financial crisis in Turkey with international repercussions due to financial contagion. It is characterized by a plunging value of the Turkish lira, high inflation, rising borrowing costs and corresponding loan defaults. The crisis is generally considered to be caused by an excessive current account deficit and foreign-currency debt in the Turkish economy in combination with President Recep Tayyip Erdoğan's increasing authoritarianism and unorthodox ideas about interest rate policy.

Current Account Deficit and Foreign-Currency Debt

A longstanding characteristic of the economy of Turkey is a low savings rate. Since under the government of Recep Tayyip Erdoğan, Turkey has been running huge and growing current account deficits, reaching US$7.1 billion by January 2018, while the rolling 12-month deficit rose to $51.6 billion, one of the largest current account deficits in the world. The economy has relied on capital inflows to fund private-sector excess, with Turkey’s banks and big firms borrowing heavily, often in foreign currency.

In the period leading up to the crisis, investment inflows had already been declining due to Erdoğan picking fights with countries that were major sources of such inflows (such as Germany, France, and the Netherlands), amid worries about the rule of law in Turkey after the 2016 coup attempt that prompted the government to seize the assets of those with even tangential ties to the coup, and worries about the lira whose decreased value threatens to eat into investor profit margins. Investment inflows also declined because Erdoğan's ever increasing authoritarianism has quelled free and factual reporting by financial analysts in Turkey.

By the end of 2017, the corporate foreign-currency debt pile in Turkey had more than doubled since 2009, to $214 billion after netting against their foreign-exchange assets. Turkey's gross external debt, public and private, stood at $453.2 billion at the end of 2017. As of March 2018, $181.8 billion of external debt, public and private, was due to mature within a year. Non-resident holdings of domestic shares stood at $53.3 billion in early March and at $39.6 billion in mid-May, non-resident holdings of domestic government bonds stood at $32.0 billion in early March and at $24.7 billion in mid-May.

Presidential Interference with the Central Bank

Money supply in Turkey has grown at an annual rate of 16 percent since 2014 and 18 percent since 2016. This compares to an annual money supply growth, as calculated under orthodox economic theory by economist Steve Hanke, of no more than 13 percent in order to meet the central bank’s inflation goal of 5 percent. As a consequences of these easy money policies, Turkey has experienced substantially higher inflation than other emerging markets. In 2018, the lira's exchange rate accelerated deterioration, reaching a level of 4.5 USD/TRY by mid-May and of 4.9 USD/TRY a week later. Among economists, the accelerating loss of value was generally attributed to Recep Tayyip Erdoğan preventing the Central Bank of the Republic of Turkey from making the necessary interest rate adjustments.

Erdoğan, who claimed interest rates beyond his control to be "the mother and father of all evil", in a 14 May interview with Bloomberg claimed unorthodox interest rate theories and said that "the central bank can't take this independence and set aside the signals given by the president." Presidential interference with central bank policy comes with a general perception in international investment circles of a "textbook institutional decline" in Turkey, with Erdoğan seen increasingly reliant on politicians whose main qualifications for their jobs is loyalty at the expense of more qualified and experienced options. Erdoğan also has a long history of voicing Islamist discourse of interest based banking as "prohibited by Islam" and "a serious dead-end".

Economist Paul Krugman described the unfolding crisis as "a classic currency-and-debt crisis, of a kind we’ve seen many times", adding: "At such a time, the quality of leadership suddenly matters a great deal. You need officials who understand what’s happening, can devise a response and have enough credibility that markets give them the benefit of the doubt. Some emerging markets have those things, and they are riding out the turmoil fairly well. The Erdogan regime has none of that.”

Consequences in Turkey

During the emergence of the crisis, lenders in Turkey were hit by restructuring demands of corporations unable to serve their USD or EUR denominated debt, due to the loss of value of their earnings in Turkish lira. While financial institutions had been the driver of the Istanbul stock exchange for many years, accounting for almost half its value, by mid-April they accounted for less than a third.

Banks continuously raised interest rates for business and consumer loans and mortgage loan rates, towards 20 percent annually, thus curbing demand from businesses and consumers. With a corresponding growth in deposits, the gap between total deposits and total loans, which had been one of the highest in emerging markets, began to narrow. However, this development also led to unfinished or unoccupied housing and commercial estate littering the outskirts of Turkey’s major cities, as Erdoğan's policies had fueled the construction sector, where many of his business allies are very active, to lead the earlier overheating economic growth. In March 2018 home sales fell 14 percent and mortgage sales declined 35 percent compared to a year earlier. As of May, Turkey had around 2 million unsold houses, a backlog worth three times average annual new housing sales.

Timeline of events

• 12 February – Yildiz Holding unexpectedly requested to restructure as much as $7 billion in loans.

• 21 February – Cemil Ertem, a senior economic adviser to president Recep Tayyip Erdoğan, published an opinion piece in the Daily Sabah suggesting that the International Monetary Fund's policy advice for Turkey's central bank to raise short term interest rates should be ignored and that "not only Turkey, but all developing countries, should do the opposite of what the IMF preaches."

• 5 April – Mehmet Şimşek, the deputy prime minister in charge of the economy, sought to resign due to disagreement with president Erdoğan about the latter's interference with central bank policy, but later was convinced to withdraw his resignation.

• 7 April – Dogus Holding applied to its banks for debt restructuring. Dogus’ outstanding loans stood at the equivalent of 23.5 billion Turkish lira ($5.81 billion) at the end 2017, up 11 percent from the year before.

• 18 April – President Erdoğan announced that the upcoming general election would be held early on 24 June.

• 14 and 15 May – In a televised interview with Bloomberg and in a meeting with global money managers in London, Erdoğan said that he intends to take greater control of the economy including de facto control over monetary policy after the elections and implement lower interest rates, causing "shock and disbelief" among investors about the central bank’s ability to fight inflation and stabilize the lira.

• 23 May – Foreign exchange bureaus in Istanbul temporarily stopped trading amidst an extreme dive in the price of the lira.

• 23 May – The Turkish Statistical Institute reported another slip in consumer confidence over the month of May, with all sub-indices decreasing. On 25 May, it reported a sharp drop in confidence in Turkey’s services, retail trade, and construction sectors over the month of May.

• 23 May – The Central Bank of Turkey raised interest rates at an emergency meeting of its Monetary Policy Committee, bowing to pressure from financial markets. The central bank raised its late liquidity window rate by 300 basis points to 16.5 percent. Taken against the vociferous objections of Erdoğan, this step brought temporary relief for the lira exchange rate.

• 26 May – Erdoğan at a campaign rally threatened "the finance sector" with indeterminate sanctions if it does not rescue the flagging lira, and implored his supporters to change any foreign-currency holdings into lira.

• 28 May – Turkey's central bank announced an operational simplification of its monetary policy, effective 1 June, coming with the announcement of another interest rate hike. The currently not used one-week repo rate, at 8 percent, shall be raised to 16.5 percent and become the future benchmark of monetary policy. The current benchmark late liquidity window rate, now at 16.5 percent, will be fixed at 150 basis points above the one-week repo rate, which would now be 18 percent. The lira somewhat firmed in response.

• 30 May – The Turkish Statistical Institute reported economic confidence sliding steeply in May to a value of 93.5, the lowest level in 15 months, since the aftermath of the 2016 coup attempt.

• 30 May – GAMA Holdings sought to ease repayment terms for $1.5 billion of loans with creditors.

• 30 May – Turkey's central bank released minutes of the crucial 23 May Monetary Policy Committee meeting, saying that "the tight stance in monetary policy will be maintained decisively until the inflation outlook displays a significant improvement and becomes consistent with the targets,” the latter being 5 percent by law.

• 1 June – The Istanbul Chamber of Industry published its index of manufacturing in Turkey for the month of May, revealing that with a sharp drop for the second consecutive month, manufacturing conditions deteriorated to the worst since 2009, elaborating that "inflationary pressures remained marked in May, cost burdens continued to rise in the manufacturing sector."

• 4 June – Turkey’s statistics institute reported the annual inflation rate for May as risen to 12.2 percent from 10.9 percent the previous month, marking a six-months high, while monthly inflation was 1.6 percent.

International Consequences

The crisis brought considerable risks of financial contagion. According to the Bank for International Settlements, international banks had outstanding loans of $224 billion to Turkish borrowers, including $83 billion from banks in Spain, $35 billion from banks in France, $18 billion from banks in Italy, $17 billion each from banks in the United States and in the United Kingdom, and $13 billion from banks in Germany.

Timeline of events

• 19 January – Fitch Ratings closed its Istanbul office, amid a torrent of negative comments by Erdoğan about the international firms that assess Turkey’s creditworthiness, saying it had become impossible to write analysts’ reports on which credit rating actions are based, a job that requires freedom of the press and freedom of speech.

• 7 March – Moody's Investors Service downgraded Turkey’s sovereign debt, warning of an erosion of checks and balances under Erdoğan and saying that the Turkish military operation in Afrin, having strained ties with Washington and drawn the country deeper into the Syrian civil war, had added an extra layer of geopolitical risk.

• 1 May – Standard & Poor's cut Turkey's debt rating further into junk territory, citing widening concern about the outlook for inflation amid a sell-off in the Turkish lira currency.

• 22 May – Turkish government bonds traded at prices lower than those of Senegal.

• 22 May – The Turkish Republic of Northern Cyprus (TRNC) government started discussing abandonment of the Turkish lira for another currency.

• 23 May – The Central Bank of the TRNC banned public and private sector employees who do not receive their salaries in foreign currencies from taking out foreign currency loans in an attempt to limit the damage of the plummeting lira.

• 28 May – Jordan terminated the free trade agreement with Turkey, which had lately seen Turkish exports to Jordan increase fivefold.

• 30 May – Moody's Investors Service lowered its estimate for growth of the Turkish economy in 2018 from 4 percent to 2.5 percent and in 2019 from 3.5 percent to 2 percent.

https://en.wikipedia.org/wiki/Turkish_currency_and_debt_crisis,_2018