Turkey Currency Crisis Explained: Why is the ‘Lira’ in Free Fall?

The lira’s fall has been made worse by President Recep Tayyip Erdogan’s statements on economic policy. Image used for representational purpose.

(Photo: AP)

Turkey’s central bank announced a series of measures on Monday to free up cash for banks as the country grapples with a currency crisis sparked by concerns over President Recep Tayyip Erdogan’s economic policies and a trade and diplomatic dispute with the US.

The Turkish lira has nosedived over the past week and tumbled another 7 percent on Monday as the central bank’s measures failed to restore investor confidence.

The currency hit a record low of 7.23 per dollar late on Sunday after Erdogan, in a series of speeches over the week, showed no sign of backing down in the standoff against the US, a NATO ally.

He threatened to seek new alliances and partners and warned of drastic measures if businesses withdraw foreign currency from banks.

Here is a look at the situation — what caused the plunge and what impact it might have.

Why Is Turkey’s Currency so Weak?

Turkey's economy has grown strongly in recent years, but that has required a lot of foreign investment and the country imports more than it exports. Together, that can weigh on the currency.

As the currency weakens, it can make foreign investors pull their money out of Turkish stocks and bonds as their lira investments lose value. To do that, they have to sell lira — worsening the rout.

The lira's fall has been made worse by President Recep Tayyip Erdogan's statements on economic policy. He has urged the central bank to not raise interest rates. Rate increases are the central bank's main tool to support the currency and fight inflation. The central bank, officially independent, appears to have heeded Erdogan and has not raised rates when many — including the International Monetary Fund — said it should have. That drained investor confidence in the central bank, leading to a further sell-off of the currency.

Erdogan's decision to name his son-in-law as finance minister also made people wonder about the direction of the country's economic policy.

What About the Dispute With the US?

Turkey's decision to jail a Protestant pastor from the US has led to the US imposing sanctions on two Turkish government ministers. Conservative evangelical Protestants are a key constituency at home for US President Donald Trump.

The mere fact that the US would impose sanctions on Turkey — a stalwart NATO ally for decades during the Cold War — has increased uncertainty about the future in Turkey.

Trump raised the stakes on Friday, 10 August, when he said that his administration would double its tariffs on Turkish steel and aluminium. That caused a further drop in the lira. The US was Turkey's biggest export market for steel last year, though exports have fallen since.

How Is the Fall in the Lira a Problem?

It is a problem for Turkish businesses and banks that get revenues in lira and owe money in dollars or euros. The lira has fallen about 40 percent against the dollar this year. That makes a loan in dollars that much more expensive to repay. So the sudden fall raises the possibility of corporate bankruptcies or bank failures that could hurt the economy.

The currency drop will also increase the cost of living for people in Turkey by making imports more expensive. Prices are already up 16 percent since last year and this week's drop will make that worse.

What Impact Could the Turmoil Have Outside Turkey?

There are some concerns about whether European banks would suffer losses on loans in Turkey. The euro currency dropped to a 13-month low on Friday, 10 August and bank shares fell.

Europe is also dependent on Turkey to restrain the flow of migrants from conflict in the Middle East in return for aid. Some 4 million displaced people, most them from Syria, are currently living in Turkey. Any resumption of serious migrant flows from Turkey would be a big political issue in Europe, where opposition to immigration has fueled the rise of right-wing parties such as Itay's League and the Alternative for Germany.

But Carsten Hesse, analyst at Berenberg bank in London, says that an economic downturn in Turkey would have limited impact on Europe or other major economies. A 20 percent fall in exports would only reduce GDP by 0.1 percentage point or less per year in the 19 countries that use the euro currency. Hesse said that European banks could suffer losses if they loaned money in Turkey or owned Turkish banks but that the possible losses were not large enough to trigger a eurozone banking crisis.

What Is Erdogan Proposing to Do?

Erdogan gave a speech on Friday that mainly blamed foreigners for trying to destabilise the country. He equated the financial turmoil to the 2016 coup attempt that sought to depose him.

Change the euros, the dollars and the gold that you are keeping beneath your pillows into lira at our banks. This is a domestic and national struggle.

President Recep Tayyip Erdogan said in his speech

His finance minister later promised that the central bank would remain independent and that inflation would come down. With little by way of detail, the promises failed to soothe markets.

(Published in an arrangement with AP.)