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.
What is the international economic context facing Turkey? The U.S. economy is growing strongly, but Turkey exports much more to the European Union, where growth has slowed and is not predicted to pick up strongly.
Global interest rates are rising as the Federal Reserve continues to reverse earlier monetary easing and the European Central Bank is expected to as well. That means U.S. financial markets are attracting more capital, strengthening the U.S. dollar on global markets. This of course increases the cost to Turkey’s businesses and banks of meeting their dollar-denominated obligations.
On the plus side, Qatar just announced it would invest $15 billion in Turkey’s economy. The news helped momentarily stabilize the lira, along with stronger controls over some foreign exchange transactions, but with few details of Qatar’s aid known, it appears unlikely to be a large cash infusion that would bolster foreign exchange reserves.
German Chancellor Angela Merkel has also made some positive comments, but no announcement of aid.
Will China or Russia help Turkey by providing a multibillion dollar loan to shore up Turkey’s foreign exchange reserves? This is highly unlikely without economic reforms that will enable Turkey to repay any loans.
Where does that leave the rest of the emerging markets? Many have adopted more flexible exchange rates, providing a cushion and promoting adjustment in trade accounts. Nonetheless, a number of countries have been facing market pressure, including South Africa, India, Indonesia and Argentina.
South Africa and Argentina have the lowest foreign exchange reserves relative to imports and debt service payments, but Argentina has an IMF program and is implementing needed adjustment measures. India has high foreign exchange reserves.
South Africa and Indonesia have current account deficits and have opened their economies to short-term capital flows, which can quickly reverse if investor sentiment sours, increasing vulnerability to capital outflows.
A number of emerging market central banks have raised interest rates to shore up investor confidence, which slows domestic growth. Domestic resistance to further interest rate hikes or budget cuts may lead central banks to support their currencies and cushion falling currencies instead.
Where does that leave the broader group of emerging markets? Turkey’s resistance to needed economic adjustment is prompting investors to reassess emerging market investment more broadly. If sentiment sours on other emerging markets, resulting capital outflows will fuel a wider crisis. That will likely slow global growth and impact all countries.
Meg Lundsager is a public policy fellow at the Wilson Center where she focuses on economics and globalization. She is the former U.S. executive director of the IMF.