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The Turkish currency crisis

Libya, Syria, Aegean Sea (therefore Greece, France and NATO).
These are the cornerstones of the foreign policy operations of Turkish President Recep Tayyip Erdoğan.
The central problem for Turkey, however, are not foreign disputes but domestic policy, more precisely economic and currency problems.
Moody’s, one of the largest rating agencies in the world, in fact, in the last few days, has cut the rating of Turkey, classifying it B2 as a third world country like Rwanda.
The loss of value of the local currency, the Turkish lira, is therefore in danger of causing the foreign deficit to get out of control as well as creating a serious internal economic crisis. One of the litmus paper will arrive in October when “a large slice” of the debts in dollars contracted in recent years will come due.

The Turkish economic situation is therefore particularly serious and delicate, Turkish foreign exchange reserves are drying up. The latter, in particular dollars or euros, have always been essential to repay debts incurred in foreign currency.
What has generated this deficit?
The main reason for this chronic deficit is the importation of energy and foreign products with high added value and at the same time a modest level of domestic savings.
This has generated a dramatic imbalance.
The massive inflow of foreign investment over the last decade has dampened this situation. Now, for various reasons, these foreign investments are struggling to arrive and everything has begun to falter, indeed it seems that everything is about to collapse.
Moreover, this situation could quickly worsen.

Basically this has been the main reason why the US rating agency Moody’s has reduced the rating on the country’s creditworthiness.
In fact, as I wrote earlier, Moody’s downgraded the Republic of Turkey’s rating from B1 to B2. This rating for the Republic is definitely the lowest ever. This classification puts Turkey on a par with countries with fragile and unsafe economies such as Rwanda, Uganda, Egypt, Jamaica, Sri Lanka or Nigeria.
Moody’s vote indicates a highly speculative investment, something to stay away from if you are not looking for strong emotions. Moody’s then explained in a note that “the financial parameters could deteriorate faster than expected”. Moody’s added that “Turkey’s external vulnerabilities are increasingly likely to crystallise in a balance of payments crisis”.
According to Moody’s statements, the conditions in Turkey are therefore worrying, although the situation is, in theory, even more, problematic than the rating agency describes.

In fact, the central bank of Turkey (TCMB) is using a system whereby it obtains foreign currency from the deposits of the country’s individual banks (i.e. from the accounts of Turkish citizens) with a repayment commitment. This translated means that at the moment the Turkish central bank has no reserves of its own.

However, it remains to be assessed by rating agencies such as Moody’s, Standard & Poor’s or Fitch Rating. These are an expression of US finance and are therefore also influenced by special interests.
What is certain is that the downgrade is only the latest episode of currency and economic crisis that has been dragging on for some time and which has increased with the explosion of the COVID emergency.
In fact, Turkey’s foreign exchange reserves, expressed as a percentage of GDP, are at their lowest level for decades.
This is significantly weakening the government’s ability to repay its debts in foreign currency and increasing the country’s vulnerability to “investor moods”. Like other emerging economies, Turkey is between a rock and a hard place.
In fact, the Turkish lira is depreciating sharply. Since the beginning of the year, it has lost 22% against the dollar. This certainly makes it more challenging to repay debts incurred in US currency. 

During the course of this year, starting in March, the situation had found a certain stability thanks to the intervention of the central bank, which had spent 65 billion dollars to buy Turkish lira, thus supporting its value. During the summer, however, the Turkish lira started to depreciate again. On this issue, in early August, the central bank governor explicitly stated that “the country’s monetary policies are based on the assumption that there will not be a second wave of the pandemic, otherwise…”.
What is certain is that over the next 12 months USD 170 billion in debt will fall due with a peak in repayments expected as early as October.
At present, however, foreign exchange reserves would amount to less than half of this figure. In fact, the country’s foreign exchange reserves (excluding gold) are at the lowest level as a percentage of GDP since November 2005, at around $45 billion, a drop of more than 40% since the beginning of the year.

To increase gross reserves, Turkey has approved a number of measures including a tripling of the FX swap lines with Qatar to $15 billion in May and an increase in banks’ reserve requirements. This, however, amounts to an exceptionally low buffer/bearing if measured in relation to future external debt payments.
In this sense, the EVI (external vulnerability indicator) used by Moody’s to measure the adequacy of foreign exchange reserves to cover foreign debt repayments and non-resident deposits will increase from 263% in 2019 to 409% in 2021.

What should Turkey do to support its currency?
To support its currency, the Republic of Turkey should tighten its monetary policy.
This translates into higher rates.
This monetary policy, however, would run counter to the support that the government wants to give to the economy already struggling with the most serious drop in Gross Domestic Product ever, exacerbated by the COVID emergency and all that it has caused in terms of economic slowdowns, not only national but global in general.
It’s a catch 22.
In addition to this, it should be noted that the Turkish central bank (TCMB) has long been exposed to political conditioning by the government of Recep Taypp Erdogan.
These manipulations have turned the nose up at large foreign investors, depriving the country of another source of currency.

For Recep Taypp Erdogan, in addition to the currency problems, the COVID and the bet he has decided to play should also be added.
In fact, the government decided that the city of Ankara would have a relatively rapid recovery, both in terms of tourism (which every year guarantees the inflow of more than 30 billion dollars) and trade. The objective of this rapid return to normality is to bring back foreign currencies to the country and therefore give oxygen to the reserves before they reach the level of guard.
This situation also partly explains the way in which the country is trying to gain access to oil fields in the Mediterranean, at the cost of damaging its relations with Europe and the United States. Time may pass before these crises happen. But once they happen everything happens very quickly.
Moody’s, therefore, expects that in the event of a serious crisis the government can introduce restrictions on the movement of capital out of the country, with consequent damage also to foreign investors.

By Michele Brunori

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