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Preventing the Next 2008 Crisis: Turkey’s Economic Struggles

March 12, 2019
Turkey has been plagued by political and economic instability for the past several years as President Recep Tayyip Erdogan has strived to maximize his power and strengthen his country’s economy. Turkey’s economic growth in recent years has been fueled by the accumulation of corporate and financial foreign-currency debt, which are outstanding loans in Dollars and Euros that Turkey and Turkish companies now owe to outside investors.[1] These debts now account for 70 percent of its economy. The current account deficit in the country is at an all-time high, meaning that the amount of goods and services the country imports exceeds the amount it exports.[2][3] Due to the strengthening of the dollar, Turkey is now experiencing difficulties in repaying its loans and is thus in danger of default. It is in the interests of the global community to prevent a Turkish default, which could spread to other countries.

The possibility of a stable political and economic situation in the country has been undermined by terrorism, a recent 2016 coup attempt, and President Erdogan’s moves toward authoritarianism.[4] Changes in the Turkish Constitution initiated by President Erdogan have also altered the balance of power in the country by giving the president the power to appoint ministers and judges without the approval of the parliament. This move weakens judicial independence and threatens economic security.[5][6] President Erdogan has openly denounced the strategy of the Turkish Central Bank; he criticized the raising of interest rates as a way to combat the devaluation of lira, which this year has reached 40 percent.[7] Attempts to undermine the independence of a central bank can only lead to further deterioration of the economic situation as independent central banks are the cornerstone of a sound monetary policy.[8] A recent study by Harvard University’s John F. Kennedy School of Government reiterated the need for independence of central monetary policy to be “strong” because “…to retreat on this now would be a serious mistake.”[9]

Effects on the US and the Global Community

Turkey and Turkish businesses have been borrowing large sums of foreign currency, especially dollars. Since the dollar has been gaining value, Turkey is finding it much harder to repay its debt. If Turkey defaults on its obligations, it could mean an array of consequences from devaluation of the national currency to a fall in the prices of stocks and bonds associated with the country.[10] Turkey’s debt can only be sustainable if its GDP share in the world continues to grow in relation to its partners.[11] The debt ratio for acceptance into the European Union stands at approximately 60%, which is supposed to illustrate sound and sustainable public finances that avoid an excessive deficit.[12] Comparing the Turkish debt ratio of about 70% to this benchmark reveals that not only is the nation ineligible to become a part of the European Union—a goal Turkey has been striving towards for years—but also supports the interpretation that Turkey’s level of debt is unsound and unsustainable. According to Dani Rodrik of Harvard University, Turkey’s growth has been a result of globalization and cheap foreign capital, which allowed Turkey to borrow from countries like France and the United States at low interest rates in order to fund infrastructure projects and business ventures.[13] However, since the price of that capital (i.e. interest rate) has been growing and the rate of globalization has slowed down, Turkey finds itself struggling to push its economy towards growth. Therefore, Turkey should look towards other ways of stimulating economic growth such as increasing productivity and developing new technologies. This would allow them to boost their GDP and then repay the debts instead of having to increasing their debt ratio even more.

Although Turkey is not part of the European Union and is not tied to its Central Bank, Turkey’s economy could still provoke significant market turmoil in the case of a meltdown. Some of the largest banks in Europe such as UniCredit, BBVA, and BNP Paribas are lenders to Turkey — their home countries of Italy, Spain and France, respectively, will be the first ones to take a hit. Italy and Spain are already some of the weakest economies in the European Union, one with a high deficit spending budget and another with an unemployment rate of almost 15%.[14] This might have significant negative effects on the European economies if they are forced to step in and bail out those countries at the cost of other member states. American investors own nearly 25 percent of the outstanding Turkish bonds and more than half of publicly traded stocks from Turkey.[15] A sharp decline in the value of Turkish stocks could have a negative impact on a large number of American investors.

All of the aforementioned possible outcomes could consequently trigger another financial meltdown that would be felt by both the neighboring Europe and the US. The 2008 crisis which began with the US financial meltdown had repercussions all over the world. If the US or any other similarly large economy will suffer as a result of a Turkish default, it could set off a domino effect around the globe. Some prime examples of such occurrences are the 1997 collapse of the Baht in Thailand, which caused financial crises all over East Asia, and the 1998 devaluation of the Russian Ruble, which was felt by the United States due to its contribution to the collapse of Long-Term Capital Management hedge fund.[16] In the case of Thailand, its government has accumulated a large level of foreign currency debt, similarly to Turkey today, which caused investors to pull their capital out of the region.[17] The following year, the Russian economy experienced a similar fate when its currency was devalued due to a high deficit budget and low foreign currency reserves. American investors, who were exposed to Russian equity and bonds through the Long-Term Management, suffered losses and the hedge fund had to eventually close.[18] These are prime examples of how a collapse of a foreign economy/currency can affect the economies of other nations.

Possible Solutions

Turkey is not alone in dealing with this problem. Argentina and South Africa have also recently faced currency devaluations due to their high levels of foreign-currency debt. Recently, the International Monetary Fund (IMF) approved a 57-billion-dollar program in order to help offset a catastrophic recession in Argentina. One of the main reasons for this program is the fear of investors that, otherwise, Argentina will default on its debt payments and its currency will further depreciate.[19] Since Turkey is in a similar situation, although not as drastically as Argentina currently is, it could seek the help of the IMF. Considering that the US is one of the main supporters of the IMF, it holds significant influence with the organization. Therefore, it should cooperate with the IMF to create a plan that would mitigate further deterioration of the economic situation in Turkey.

One of the areas where the US could have a direct effect on the Turkish economy is through trade. Earlier this year, President Trump announced that he will place tariffs on imported steel. Making an exemption from these tariffs for Turkey could be beneficial for both sides. Turkey’s steel industry suffered a big blow after Trump announced the tariffs, as Turkish steel exports to the United States decreased by 54%. This will not solve Turkey’s problems alone, since the United States is not one of the top customers for Turkish steel.[20] However, while it is true that this policy wouldn’t have a massive economic effect, it would still be a big step towards repairing American-Turkish relations. This action would increase the chances of Turkey viewing help from the United States more favorably, instead of interpreting it as outside meddling in internal affairs. While the action of actively helping the Turkish industries could be seen as a deviation of the Trump’s administration from its original goal of putting “America First”, the administration could justify it as necessary means to an end. Avoiding a defaulting Turkey will prevent a financial crisis in the United States, which could have far worse implications than a small increase in competition in the steel industry.

Turkey has previously reached out to the United States in an effort to have the US relieve it of billions of US dollars in fines in return for the release of an American pastor, Andrew Brunson, who has been imprisoned in Turkey. The Trump administration rejected this appeal. While this situation did not resolve the Turkish economic crisis it showed the US, it showed that Turkey needs and wants help. Even if the Turkish government continues to put up a hostile front in regards to the US, the US has a massive economic leverage.

Therefore, the US could play a vital role in preventing a meltdown of the Turkish economy. The US could work with the IMF to provide the Turkish government with logistical support in revamping their fiscal and monetary policies that would allow them to limit the risks of the current deflation. This means that according to logical economic theory, the government of Turkey should abandon its goals of high economic growth and accept more moderate growth rates, which will be more sustainable.[21] There needs to be a push for economic reform and a move towards a moderate growth level achieved through policies other than borrowing, which has reached an unsustainable level. If the IMF decided to pursue a program with Turkey, they should aggressively advocate for the Turkish government’s acceptance of outside expertise. When a government leader advocates for interest rates that would only exacerbate his country’s inflation, as Erdogan has, it is cause for concern about the country’s monetary policy. This highlights the need for outside council.

Conclusion

The current economic situation in Turkey is subject to deterioration without an intervention. The level of foreign-currency debt that Turkey has amassed exceeds acceptable levels. The effects of these economic problems could be felt not only by the neighboring countries and largest economic partners, but also by the globalized economic community associated with Turkey.

The United States, with its extensive economic ties with the European Union, cannot stand by and let this crisis to exacerbate. If Turkey were to be pushed into survival mode by an economic default, it would become much more susceptible to outside influence such as the numerous interest groups with goals to push the US out of Middle Eastern Affairs and terrorist organizations looking to expand their networks free of US interference. While there is still time, preventative measures are the global community’s best bet in resolving the economic issues in Turkey. The United States could help prevent a Turkish economic default by leading such global efforts. The recent events in Turkey, where a Saudi-American journalist was killed in the Saudi embassy in Turkey, brought Turkey into center stage in the global arena. Now is as good of a time to reach out to Turkey and offer them a helping hand as a fellow democratic country. This crisis shows that not all is lost and there is still a chance that President Erdogan is willing to accept some of the Western values of human rights, democracy and free speech.

Attempting to repair the US-Turkish relations would boost investor confidence by calming their fears about a possible Turkey default or a rift between the two nations. It would also improve the chances that Turkey will accept international intervention. Having the IMF agree on a program for Turkey is only the first step. There is also the problem of making sure Turkey is on board with the new program. Improving the US-Turkey relations will be helpful in making Turkey accept new economic policies. Improving Turkey’s economy will strengthen the country against outside influence, thus protecting US interests in the area. Therefore, the United States cannot expect a show of good faith from Turkey, without showing some good faith first.

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  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Wharton Public Policy Initiative’s strategies, recommendations, or opinions.

References

   [1]https://www.nytimes.com/2018/07/10/business/turkey-economy-erdogan.html?action=click&module=RelatedCoverage&pgtype=Article®ion=Footer

   [2]https://www.nytimes.com/2018/08/11/business/turkey-lira-crisis.html

   [3]http://www-bcf.usc.edu/~aimrohor/Turkey_CA_Deficit.pdf (pg. 2)

  [4]https://edition.cnn.com/2017/04/15/europe/turkey-erdogan-referendum-politics/index.html

   [5]https://edition.cnn.com/2017/04/15/europe/turkey-erdogan-referendum-politics/index.html

   [6]https://www.brookings.edu/wp-content/uploads/2016/06/200603dam.pdf (pg. 1-4)

  [7]https://www.nytimes.com/2018/08/13/business/turkey-lira-emerging-markets.html

  [8]https://www.economist.com/finance-and-economics/2018/10/20/a-debate-about-central-bank-independence-is-overdue

  [9]https://www.hks.harvard.edu/sites/default/files/centers/mrcbg/working.papers/x87_final.pdf (pg. 59)

  [10]https://www.nytimes.com/2018/08/11/business/turkey-lira-crisis.html

  [11]http://www-bcf.usc.edu/~aimrohor/Turkey_CA_Deficit.pdf (pg. 4)

  [12]https://ec.europa.eu/info/business-economy-euro/euro-area/enlargement-euro-area/convergence-criteria-joining_en

  [13]http://drodrik.scholar.harvard.edu/files/dani-rodrik/files/turkish_economy_in_comparative_perspective.pdf

  [14]https://www.nasdaq.com/article/spains-unemployment-falls-in-november-for-the-first-time-since-july-20181204-00111

  [15]https://www.nytimes.com/2018/08/11/business/turkey-lira-crisis.html

   [16]https://www.nytimes.com/2018/08/11/business/turkey-lira-crisis.html

  [17]https://epubs.scu.edu.au/cgi/viewcontent.cgi?article=1341&context=comm_pubs (pg. 8)

  [18]https://files.stlouisfed.org/files/htdocs/publications/review/02/11/ChiodoOwyang.pdf (pg. 14-15)

  [19]https://www.nytimes.com/2018/08/13/business/turkey-lira-emerging-markets.html

  [20]https://www.trade.gov/steel/countries/pdfs/exports-Turkey.pdf (pg. 3-5)

  [21]http://drodrik.scholar.harvard.edu/files/dani-rodrik/files/turkish_economy_in_comparative_perspective.pdf

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