The Turkish Lira Crisis: Why it threatens the EU and how it can be averted

Josh Moss // 31.08.2018

In the last decade, Turkey’s economy has been experiencing high growth rates, partially due to a highly expansive monetary policy. However, in the process, it became highly dependent on borrowing in foreign currencies. These debts have consequently doubled since 2009.

To make matters worse, the Turkish president, Recep Tayip Erdogan, has undermined the independence of the Central Bank, due to his belief that higher interest rates worsen inflation, as opposed to reducing it.

The pressure on the Turkish economy was further aggravated by the US’ decision to impose sanctions due to Erdogan’s refusal to release Andrew Brunson, an American pastor, who has been arrested over questionable terrorism charges.

On top of that, President Donald Trump has announced that he will double tariffs on Turkish steel and aluminium in retaliation, and as part of fulfilling his protectionist stance on trade.

All of this has resulted in the lira losing more than 35 percent of its value against the US dollar this year, which has further worsened inflation while increasing Turkey’s foreign currency debts.

The downward economic spiral in Turkey can have a major impact on Europe as well. Javier Santacruz, head of research at Civismo, outlined how Europe has various financial interests tied to Turkey.

In the first trimester of 2018, Spain’s banking system was the most exposed amongst its EU counterparts to the Turkish economy, with banks such as BBVA and its Turkish subsidiary, Garanti, bearing the brunt of the debt which amounts to $82.3 billion. Others include France ($38.4 billion), UK ($19.2 billion), Germany ($17.1 billion) and Italy ($16.9 billion).

When calculating bank exposure, he also points out that one has to include Turkish bonds owned by the banks, especially those from the UK and France. They have an accumulated value of $64.3 billion, according to the Bank of International Settlements.

According to Eurasia Group, a consultancy, EU-Turkey relations could improve as a result of this crisis, due to the fact that both have suffered from US sanctions.

Although it is true that the EU has openly criticised US actions against Turkey, which was subsequently met with a positive response from Erdogan’s government, further cooperation between the two is highly doubtful. This is because although there are various mechanisms capable of improving Turkey’s situation, they are unlikely to be successfully applied, owing to a lack of willingness on behalf of both parties.

One of the easiest ways to resolve the crisis would be internal economic reform. Erdogan should hand back political and economic independence to the Central bank so it can raise interest rates. This would lower inflation, and cause an appreciation of the Lira, making foreign currency exchange cheaper.  However, this seems completely unfeasible, given his previous illiberal and centralising political decisions.

Another option would be to provide financial assistance to Turkey via the IMF. However, this is difficult to do without the US’ approval, which is unlikely, given the aforementioned breakdown in American-Turkish relations. Neither Erdogan, nor Trump, seem willing to back down and risk looking weak.

The EU itself can provide financial assistance in the form of instruments such as the Macro-Financial-Assistance (MFA) programme, which is reserved for non-EU partners. However, Bruegel, a Brussels-based think tank, claims that this would also not be very practical, since one of its main conditions for providing aid is that the receiving country has a good human rights record and a fully functioning democracy. This would be difficult to justify, given Erdogan’s purging of the media and political opponents. Furthermore, this would also require IMF involvement to a certain extent. Even if both hurdles could be overcome, MFAs typically amount to very little relative to how much would be needed to bailout Turkey in its current crisis.

In the end, the best option to address the crisis would be for Erdogan to give up control of the Central Bank and Turkey’s monetary policy. If Erdogan does not compromise, the Turkish economy will continue to suffer.

This article was inspired by a Civismo publication.


EPICENTER publications and contributions from our member think tanks are designed to promote the discussion of economic issues and the role of markets in solving economic and social problems. As with all EPICENTER publications, the views expressed here are those of the author and not EPICENTER or its member think tanks (which have no corporate view).

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