Turkey is struggling with an economic crisis that threatens to have global repercussions. This situation is the product of both economic and political calculations, with the latter, as usual, exacerbating the former. Turkey’s president, Recep Tayyip Erdogan, is playing the nationalist card to respond to the situation, which will make things worse. The question now is whether Turkey’s woes can be contained.
Turkey’s problems stem from a growth at all costs mentality that paid little attention to soaring current account deficits, stratospheric debt levels and accelerating inflation. The era of low interest rates prompted borrowing with abandon: It is estimated that Turkey’s foreign currency debt exceeds 50 percent of gross domestic product, and its current account deficit hit 6 percent of GDP this year. Turkey’s corporations are estimated to face a net foreign currency shortfall of more than $210 billion. Inflation tops 15 percent, more than three times the central bank’s target. This year, the lira, Turkey’s currency, has already lost more than 40 percent of its value against the dollar.
Alarm bells are ringing. Economists have three concerns. First, there is the danger that Turkey cannot pay off its debts and could default. Loans have to be put to productive purposes to get paid off — the swelling current account deficit suggests they have not — and a devalued currency makes paying off foreign loans more difficult still. The yield on Turkish government 10-year bonds exceeded 22 percent last week and five-year credit default swaps — essentially insurance against default — jumped 75 basis points to 453 basis points last Friday, the highest level since March 2009. It is now the most suspect government debt in the world.
Second, there is concern that defaults — corporate or government — will hurt the financial institutions that extended those loans. Turkey owes an estimated €140 billion ($159 billion) to European banks. The most exposed are large Spanish banks, which loaned about $82 billion, and French banks, with $38 billion in loans outstanding. While most observers believe that the financial institutions’ exposure is limited — Spanish loans, for example, comprise just 4.5 percent of those banks’ total assets — bank stocks have been battered, with some European banking shares falling 3 to 4 percent.
The prospect of market overreaction to the crisis is the third potential danger. Investors fear that Turkey is merely the first economy to suffer the impact of a new global economy in which interest rates no longer remain at zero; other countries will soon face the same problems. To prevent losses, investors will pull out of emerging markets, intensifying the credit squeeze. That is already beginning. Currencies in South Africa, Mexico, Indonesia, India and Argentina have declined in value against the dollar. One emerging-market currency index fell to its lowest point in more than a year. Economists caution, however, that a repeat of the 1997 Asian financial crisis is unlikely: Governments learned their lessons from that episode and have reduced their vulnerabilities.
Turkey has failed to respond, however. The central bank has boosted foreign exchange liquidity, but the moves are too small to have much impact. It has raised interest rates 500 basis points since April and the main rate is 17.75 percent, but the bank did not further increase rates at its last meeting, prompting fears that the problem is now political rather than economic.
Erdogan holds unconventional economic beliefs. He thinks that high interest rates spur inflation, rather than tamp it down. He has installed his son-in-law as minister of finance and the treasury, preferring sycophancy to experience. He insists that the economy is “solid, strong and intact,” and counters that the country is at “economic war” and is threatened by outside forces. He is referring to U.S. President Donald Trump, who has imposed sanctions on Turkey because of its refusal to release a U.S. missionary charged with espionage and terrorism. Trump tweeted that he is prepared to increase those sanctions, and Erdogan responded by imposing tariffs on a range of U.S. imports and has called for a boycott on U.S.-made electronic goods.
Most observers believe that a bold step is required. Erdogan has ruled out one option — an agreement with the International Monetary Fund — and could instead embrace capital controls.
Japan must brace for the fallout. Firms that trade with Turkey or invest in it must prepare for a liquidity crisis. Japanese banks had some exposure, with outstanding loans totaling $10.9 billion in the quarter ending last March. They must also be ready for the ripple effects in the emerging markets of Asia with which they do considerable business. Uncertainty in currency markets has typically meant a rush for safe havens, like the yen. Some appreciation in the yen’s value is to be expected.
The damage should be contained, however, as long as sentiment does not outpace reality. Turkey provides reason for concern, but not for panic.