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Why this might be the Ground Zero Hour for the Turkish Lira

When a serious economist and expert as James G. Rickards, the editor of Strategic Intelligence with 35 years of experience working in capital markets on Wall Street (or even the Turkish economist Mustafa Sonmez) states that the turkish lira will be ground zero in the next global debt crisis we must take his words seriously and try to analyse what is the real situation in this country.

Korkut Boratav, one of Turkey’s most respected economists, said a run to the IMF is almost inevitable for Turkey in 2019, regardless of who wins the upcoming presidential and parliamentary elections. President Erdogan insisted the lira’s volatility did not reflect economic reality and warned that he would not let “global governance types ruin the country.”

The economist James Ricards notes that the risk of a major debt crisis beginning in Turkey is heightened by the rise of Turkey’s President Recep Tayyip Erdoğan as an autocratic strongman in the mold of Argentina’s Juan Perón and other populist nationalists who have ruined strong economies. Currently, the turkish debt is 42.4 of the country’s GDP.

Turkey balance of payments current account

The current account balance seems to be an abstruse economic concept. But in countries that are spending a lot more abroad than they are taking in, the current account is the point at which international economics collides with political reality. When countries run large deficits, businesses, trade unions, and parliamentarians are often quick to point accusing fingers at trading partners and make charges about unfair practices.

For Turkey is not the first time that it has serious  problems with its economy.In 2001, the coalition government of the late Bulent Ecevit, grappling with Turkey’s worst economic crisis, acquiesced to that option, and by implication, to the disastrous political consequences that the IMF-backed austerity program would have for the three coalition partners.

Turkey experienced a strong cyclical recovery in 2017, with 7.4% growth.The gross domestic product (GDP) numbers beat a forecast of 7.2 percent growth in a Reuters poll. It was the biggest increase in GDP since 2013.

Demand in 2017 was stimulated by fiscal measures and a Credit Guarantee Fund for small and medium enterprise (SME) financing. Total consumption accounted for over two-thirds of growth in this period. Strong demand resulted in high consumer price inflation, which averaged 11% in 2017.

Rickards noted back in February that the flood of bank lending and direct foreign investment has given rise to another flood of hot-money portfolio investors in Turkish stocks chasing high returns with cheap dollar funding in a variation of the global carry trade. So-called emerging-market (EM) funds offered by Morgan Stanley, Goldman Sachs and others are stuffed full of Turkish stocks and bonds.

Turkey’s external dollar-denominated debt is so large that a combination of rising U.S. dollar interest rates and a slowing global economy could quickly turn Turkey from model EM to the canary in the coal mine of the next great global debt crisis.

Turkey’s debt is huge, one of the highest debt burdens of any EM. Turkey owes $481 billion to foreign creditors, of which the two thirds are  denominated in hard currency, mostly dollars and euros. The remainder is denominated in Turkey’s local currency, the lira.

turkey external debt graph

Turkey’s external vulnerability remains high. Further tapering of U.S. monetary policy in 2018 could negatively affect capital flows, raising interest and exchange rate risks for Turkey’s external debt. The private sector is particularly affected as it accounts for 70% of external debt. Though most of it is long-term maturity, a weaker lira and costlier external financing might hit corporate balance sheets. Given these developments, inflation is expected to remain at just above 10% in 2018.

  • The Effects of Inflation

As inflation rises, in addition to businesses being forced to raise their prices, banks are forced to raise interest rates in order to maintain a profit margin and higher rates means that marginal businesses will fail, thus increasing unemployment and harming the overall economy.

High inflation harms everyone not just because of increased costs and increased unemployment but also due to the time lag before you get a cost of living increase. High inflation also encourages people to spend money “before it loses its value” so they will buy things they don’t need simply as a method of preserving value. They also go into debt and fail to save. In the short run this can stimulate the economy but in the long run it will result in poor choices and a less than optimal economy as everyone becomes so short sighted that they fail to plan for the long run.

The Turkish lira has collapsed since President Recep Tayyip Erdoğan became president in August 2014, leading to a surge in inflation, Steve Hanke, professor of applied economics at John Hopkins University, said in an analysis for the biweekly Forbes magazine.

While official inflation is 10.9 percent, purchasing power parity allows for a calculation of inflation based on changes in the exchange rate, which is 39.2 percent, Hanke said.

Hanke, who has advised dozens of world leaders on currency reform and how to tame hyper-inflation, said he measured the implied inflation rate in Turkey on a daily basis by using PPP to translate changes in the lira-dollar exchange rate into annual inflation.

The causes of the high rate of inflation are central bank policies, which have been “too loose for too long”, producing big growth in the money supply, Hanke said.

The money supply has grown at a rate of 16 percent since 2014 and 18 percent since 2016, Hanke said. That compares with the 13 percent growth needed to meet the central bank’s inflation goal of 5 percent, he added.

There has also been a decline in the quality of money, with the central bank replacing its dwindling foreign currency reserves with liras, Hanke said.

Demand for lira-denominated assets is also deteriorating as profit margins narrow because of the lira’s decline, Hanke said, citing the carry trade. For example, Japanese investors borrow in yen at low rates of interest to buy liras and earn higher returns.

The Turkish central bank published Wednesday a summary of its May 23 emergency meeting, where officials raised rates from 13.5 percent to 16.5 percent to stem the currency’s slide. Crucially, this included the sentence: “inflation expectations, pricing behavior and other factors affecting inflation will be closely monitored, and, if needed, further monetary tightening will be delivered.” But despite this mini surge, it is still down by nearly 17 percent against the US dollar so far this year!

This sentence had formed part of the April 25 Monetary Policy Committee statement, but its omission from the May release gave the central bank the appearance of having shifted to a more neutral policy stance. The reinstatement of the line suggests the central bank stands ready to hike if necessary.

  • The Iranian Impact on the Turkish Lira 

According to FT.com America’s decision to pull out of the nuclear deal with Tehran and re-impose sanctions has sparked a further jolt of bearishness. Among Turkey’s primary imports from Iran are petroleum products and natural gas, according to Turkey’s ministry of foreign affairs. Oil will be one of the main products that the US is expected to target in its sanctions. Turkey called the US decision an “unfortunate step”, according to the state-run Anadolu Agency.

Turkey imports large amount of its Oil needs, the increase of the Oil prices used about 0.7% of the of Turkey’s gross domestic product (GDP).

Turkey imports about 90% of its oil needs, that’s why Oil price also  impacts negatively the Lira.

According to the US Energy Information Center, Turkey imported 99% of its natural gas needs by 1.7 trillion cubic feet, 57% of which is from the Russian company Gazprom. While it imports oil from Iran and Iraq which had the biggest share of the Turkish oil imports.

  • Turkish Lira fall and its impact on Europe

According to figures from the Bank of International Settlements, which measures financial and credit flows, global banks have lent just under €200billion to Turkey.

Spanish banks have lent the troubled country £62billion (€71 billion), ahead of France (£22.6 billion), Italy (£13.6 billion) and Germany (£9.8 billion).

Spain’s BBVA owns almost half of Garanti Bank, the third largest financial centre in Turkey, with this share contributing a fifth of BBVA’s profits last year.

Even more alarming is that BBVA’s share has lost 14 percent of its value so far this year, significantly more than the 2.7 percent lost by the Spanish market as a whole.

Since the Turkish lira went into freefall, UniCredit Bank’s share has also lost a fifth of its value.

Furthermore, according to Cyprus Mail, Turkish Cypriots  in the breakaway north of Cyprus are reportedly considering adopting another currency as the plummeting Turkish lira continues to batter their economy.

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