BY MEG LUNDSAGER, OPINION CONTRIBUTOR —
Turkey’s economic performance continues to alarm its businesses and consumers, as well as international investors and lenders. Turkish businesses have borrowed increasing amounts in foreign currencies such as Euros and U.S. dollars.
Bankers and bondholders are now waking up to the reality that many Turkish borrowers may not be able to meet these obligations. The rush to the exit is underway, and the Turkish lira has fallen sharply from just a few months ago.
With credit tightening, President Erdogan has taken control over the central bank and mandated that it keep interest rates lower in order to maintain domestic credit flows to prevent an economic slowdown. The resulting higher inflation only adds to pressure on the lira.
This looks like a replay of earlier emerging market crises, this one caused primarily by Turkey’s own overly expansionary policies and rapid increase in external debt. Until Turkey decides to reverse course, raise interest rates and restore central bank independence, the situation will likely worsen and foreign as well as domestic confidence will erode further.
Turkey could turn to the International Monetary Fund (IMF) for assistance as it did a decade ago. But President Erdogan has no desire to ask the IMF for funding, knowing full well that the IMF would require significant belt tightening, central bank independence and much higher interest rates.
Further complicating this avenue are U.S. economic sanctions, raising the question of whether the U.S. would oppose an IMF program and lobby other members to also oppose (requests for IMF lending require a simple majority of IMF Executive Board votes for approval, therefore the U.S. cannot block a loan by itself).
Much of the public commentary on the evolving Turkish meltdown distinguishes Turkey as an outlier among emerging markets in terms of the severity of its economic situation. Nonetheless, the crisis in Turkey will naturally generate a re-examination of investor and lender portfolios. Key emerging market indicators are:
- Foreign exchange levels: Does the central bank have enough foreign exchange to pay for needed imports and meet external debt obligations of the private and public sector? Turkey’s official reserves have dropped perilously low in relation to import needs and Turkish firms’ debt obligations coming due.
- Current account deficits: Is the country spending much more on imports of goods and services than it is earning on exports? Turkey’s current account deficit has increased rapidly and is now about the highest among emerging markets, relative to the size of its economy.
- Total foreign debt levels in relation to the size of the economy:Turkey’s external debt obligations have risen rapidly as firms and the government issued foreign-currency-denominated debt that will continue to be a drain on reserves for the coming few years.