Blog Post

The Turkish Crisis

Financial markets have been very nervous about Turkey for the past few weeks. We review economists’ opinions about the economic, political and geopolitical risks and opportunities of this situation.

By: and Date: August 27, 2018 Topic: Global economy and trade

Jamie Powell and Colby Smith write on FT Alphaville that the Turkey crisis looks like a classic emerging-market meltdown: a rapidly growing economy funded by short-term, dollar-denominated liabilities, fronted by a strongman leader with a penchant for appointing insiders to key government positions. As such, it is evocative of the Asian currency crises of 1997 and 1998, which hold lessons for Turkey.

Brad Setser thinks instead that while Turkey has some similarities with the Asian crisis countries of the 1990s, it also has important differences. Turkey’s banks are the main reason why the currency crisis could morph into a funding crisis, one that leaves Turkey without sufficient reserves to avoid a major default. But, unlike Asian banks, Turkey has been able to use external foreign currency funding to support a domestic boom in lira-lending to households. Turkey’s banks really didn’t need to borrow foreign currency from the rest of the world to support their current level of foreign currency lending to Turkey’s firms, and their apparent wholesale funding need is for lira, not dollars. Also the real boom in credit has come not from foreign currency lending to firms, but rather from lira-lending to households. The financial mystery – which Setser then goes on to explain – is not how the banks lent foreign currency to domestic firms, but how they used external foreign currency borrowing to support domestic lira-lending.

Jacob Funk Kirkegaard writes that economic developments are driving Turkey to all but inevitably approach the IMF for its second bailout in the 21st century. Turkey’s basic difficulties derive from the twin deficits it has been running in recent years. Making Turkey’s problems worse are a range of political difficulties relating to its relationship with NATO, the European Union, and the United States, as the country is more isolated internationally than at any moment in recent decades.

The road thus points to the the IMF, but the Fund will find it difficult to help Turkey without demanding tough austerity policies in return – policies that could weaken Erdoğan’s hold on power. Erdoğan does have some potential (if unsavory) political leverage, however, as a seemingly imminent Syrian government attack just south of the Turkish border could easily unleash another refugee emergency inside Northern Syria. Turkey’s decision whether or not to open its borders and provide refuge for Syrians could well be political in nature, possibly contingent on economic aid from the West or the terms of an IMF rescue package.

Grégory Claeys and Guntram Wolff disagree and argue that a correction in Turkey’s macroeconomic policies is needed, but it is too early to say that Turkey will need a bailout programme. European policymakers should, however, reflect on what should be the EU’s position towards Turkey. A financial crisis in a neighbour country of the EU could have a direct negative impact on the EU economy, mainly through the exposure of its banks operating in Turkey and through trade.

Moreover, a crisis in Turkey could trigger possible political knock-on effects and consequent changes in Turkey’s migration policy, not to mention geopolitical threats. If an IMF programme were to be unfeasible, and EU countries were to come to the conclusion that avoiding an escalation of the crisis in Turkey is in their best interest, the EU could try to organise a financial support package on its own through its Macro-Financial Assistance (MFA) programme, reserved for non-EU partner countries. But in that case, the EU needs to form a clear view on whether such an instrument should be a way to advance democratic values, or whether the EU should have a more functional approach and limit conditionality on specific macro-structural policies.

Laurence Daziano writes that this is a chance to reset Europe’s relationship with Turkey. This should be achieved by means of an EU-Turkey treaty that would have three components. On the diplomatic and security side, the reaffirmation of Turkey’s anchoring in the western camp and Nato; on the economic side, a substantial increase in European aid and a guarantee of the independence of the Turkish central bank, and a commitment to curb inflation; and, finally, the further transposition of European standards into Turkish law. This project does not require the sensitive question of the future of EU accession talks between Brussels and Ankara to be settled. On the contrary, this is a propitious moment to propose a resetting of relations between Europe and Turkey, since Mr Erdoğan is looking for allies. At a time when Mr Trump treats Europe as a “foe” of the US, the bloc would do well to help Turkey to modernise further and to encourage the liberal and democratic values to which many Turks still subscribe, especially young people and those living in the country’s large cities.

Jim O’Neill writes that Turkey must now drastically tighten its domestic monetary policy, curtail foreign borrowing, and prepare for the likelihood of a full-blown economic recession, during which time domestic saving will slowly have to be rebuilt. Among the regional powers, Russia is sometimes mentioned as a potential saviour. While there is no doubt that Vladimir Putin would love to use Turkey’s crisis to pull it even further away from its NATO allies, Erdoğan and his advisers would be deeply mistaken to think that Russia can fill Turkey’s financial void: a Kremlin intervention would do little for Turkey, and exacerbate Russia’s own economic challenges.

Qatar, one of Turkey’s closest Gulf allies, could provide financial aid but does not have the wherewithal to pull Turkey out of its crisis single-handedly. As for China, though it will not want to waste the opportunity to increase its influence vis-à-vis Turkey, it is not the country’s style to step into such a volatile situation, much less assume responsibility for solving the problem. That means that Turkey’s economic salvation lies with its conventional Western allies, and despite his escalating rhetoric Erdoğan may soon find that he has little choice but to abandon his isolationist and antagonistic policies of the last few years.

José Antonio Ocampo argues instead that longstanding patterns in emerging markets may no longer apply. At the peak of the Turkish turmoil, in the week between August 8th and 15th, the currencies of Argentina, South Africa, and Turkey depreciated by between 8-14% against the US dollar. Yet the currencies of other emerging economies depreciated by no more than 4%.This suggests that contagion is not taking hold as easily as it has in the past, and that broad-based sudden stops may be less likely.

Even the most affected economies were able to limit the fallout of their currency collapses. This seems to reflect a new resilience to contagion that has formed over the last ten years or so. But that does not mean that emerging economies are in the clear; on the contrary, they still have plenty to worry about, not least an escalating trade war. Smart policies, together with an improved global financial safety net from the International Monetary Fund, therefore remain of the utmost importance

Alasdair Mcleod at Mises Institute is interested in long-term implications for the US dollar. He argues that President Trump’s actions over trade, which appear to have some short-term successes, are driving countries away and ultimately this will prove counterproductive. Speculators buying into Trump’s short-termism and the Fed’s normalisation policies are for the moment driving the dollar higher, without realising that foreigners, far from suffering from a shortage of dollars, already own all the excess dollar liquidity created since the Lehman crisis. The dollar is rising only on short-term considerations, but once these abate, the longer-term prospects for the dollar will reassert themselves, including the escalating budget and trade deficits, record levels of foreign ownership of the dollar, and rising prices fuelled by a combination of earlier monetary expansion and the extra taxes of trade tariffs.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Blog Post

Owning up to sustainability risks: the EU should champion international standards

To keep European Union capital markets open and integrated, new international standards should be reflected in future European law and accounting practice to provide further incentives for a reallocation of capital, reflecting in particular climate risks.

By: Alexander Lehmann Topic: Banking and capital markets, Green economy Date: April 26, 2022
Read article More on this topic More by this author
 

Opinion

China’s Covid policy to be year’s largest economic shock

Beijing’s ‘dynamic zero-Covid’ policy could devastate the domestic economy, but the effects will also be felt globally.

By: Alicia García-Herrero Topic: Global economy and trade Date: April 26, 2022
Read article More on this topic
 

Blog Post

Venture capital: a new breath of life for European entrepreneurship?

Whether the dynamism of European venture capital of the past two years can be sustained and kick start a credible alternative to bank finance in the European Union remains to be seen.

By: Maria Demertzis and Lionel Guetta-Jeanrenaud Topic: Banking and capital markets Date: February 10, 2022
Read article More by this author
 

Podcast

Podcast

Turkey’s economic struggles

Will inflation continue to surge?

By: The Sound of Economics Topic: Global economy and trade, Macroeconomic policy Date: January 26, 2022
Read article More on this topic More by this author
 

Blog Post

Better sustainability data is still needed to accelerate the low-carbon transition in capital markets

Investors need more trustworthy sustainability data. Regulators should leave space for better products to emerge, while remaining alert to well-known patterns of misconduct in capital markets.

By: Alexander Lehmann Topic: Banking and capital markets Date: October 18, 2021
Read article Download PDF More on this topic
 

Policy Contribution

Europe should not neglect its capital markets union

The European Union’s capital markets remain very underdeveloped compared to the United States. The market for equity, as measured as the size of the total market capitalisation of listed domestic firms relative to GDP, is much larger in the US and in Japan than in Europe.

By: Maria Demertzis, Marta Domínguez-Jiménez and Lionel Guetta-Jeanrenaud Topic: Banking and capital markets Date: June 7, 2021
Read article More on this topic More by this author
 

Blog Post

Confronting the risks: corporate debt in the wake of the pandemic

As European economies emerge from lockdowns, it is becoming clearer that corporate debt has reached critical levels. A new French scheme, in which the state guarantees portfolios of subordinated debt, shows how financial support could be targeted better.

By: Alexander Lehmann Topic: Banking and capital markets Date: April 28, 2021
Read about event More on this topic
 

Past Event

Past Event

Living standards and financial resilience across Europe

What has the impact of the pandemic on households’ financial resilience been, and how should policy makers respond?

Speakers: Romina Boarini, Zsolt Darvas, Maria Demertzis and Daniel Tomlinson Topic: Macroeconomic policy Date: April 21, 2021
Read article More on this topic More by this author
 

Opinion

China's yuan nowhere near cracking US dollar hegemony

For all Beijing's ambitions of cracking the hegemony of the US dollar in the face of Trump administration sanctions, the yuan still has a long way to go.

By: Alicia García-Herrero Topic: Global economy and trade Date: October 30, 2020
Read about event More on this topic
 

Past Event

Past Event

Completing the banking union in the age of Next Generation EU

Invitation only event to discuss the banking union.

Speakers: Tuomas Saarenheimo and Nicolas Véron Topic: Banking and capital markets Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 27, 2020
Read about event More on this topic
 

Past Event

Past Event

Next Generation EU debt: how is it structured?

The impact of EU debt on the EU market of safe assets.

Speakers: Gert-Jan Koopman and Guntram B. Wolff Topic: Macroeconomic policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 22, 2020
Read article Download PDF More on this topic More by this author
 

Policy Contribution

Emerging Europe and the capital markets union

The European Union's capital market union needs a revamp because of Brexit and the deep recession, and to underpin the European Green Deal. In particular, equity capital in the countries of central and eastern Europe is underdeveloped. These countries should take measures to facilitate equity finance, accompanied by reform at EU level.

By: Alexander Lehmann Topic: Banking and capital markets Date: September 17, 2020
Load more posts