Turkey’s currency the “Lira”, has plummeted in value this month, accelerating its poor performance throughout the year. Last week, Washington Post reported that so far in 2018, the Lira has lost over 60 percent of its value, which is its largest depreciation since 2001. Washington Post also reported that a new survey of Turkish voters suggests that the currency crisis is hurting the popularity of the government of President Recep Tayyip Erdogan. But the political fallout is not likely to be too sever, because the government has convinced Turkish citizens that it is not responsible for the crisis.
After the flare-up in Turkey which saw its currency 25 percent in a week, major tensions with the United States, and even talk of its entire economy collapsing, things appear to have quietened down over the past week, as Turkey settles in to try and solve its problem. Just because things have calmed down, however, doesn’t mean that Turkey is out of the woods yet.
Financial injections by Qatar and possibly China may resolve Turkey’s immediate economic crisis which is aggravated by a politics-driven trade war with the United States. However, these aid measures are unlikely to resolve the country’s structural problems, fuelled by President Recep Tayyip Erdogan’s counterintuitive interest rate theories.
The latest crisis in Turkey’s boom-bust economy raises questions about a development model in which countries like China and Turkey move toward one-man rule. The evidence is clear. It encourages massive borrowing to drive economic growth. Holger Schmieding, Chief Economist at Berenberg Bank in London stated that in Turkey and China, the debt-driven approach sparked remarkable economic growth. In the process, living standards were significantly boosted and huge numbers of people were lifted out of poverty.
Yet, both countries with Turkey more exposed, given its greater vulnerability to the swings and sensitivities of international financial markets, are witnessing the limitations of the approach. So are countries along China’s Belt and Road, including Pakistan. These countries leaped head over shoulder into the funding opportunities made available to them by China.
Holger Schmieding noted that these countries are now see themselves locked into debt traps that in the case of Sri Lanka and Djibouti have forced them to effectively turn over to China control of critical national infrastructure. Other countries like Laos have become almost wholly dependent on China because it owns the bulk of their unsustainable debt.
The fact that China may be more prepared to deal with the downside of debt-driven development does little to make its model sustainable. James Dorsey, a Senior Fellow at the S. Rajaratnam School of International Studies argued that debt-driven growth could also prove to be a double-edged sword for China itself. This is so even if it is far less dependent than other countries on imports, does not run a chronic trade deficit and doesn’t have to borrow heavily in dollars.
Ruchir Sharma, Morgan Stanley’s Chief Global Strategist and head of Emerging Markets Equity said that with more than half the increase in global debt over the past decade having been issued as domestic loans in China, China’s risk is capital fleeing to benefit from higher interest rates abroad. Referring to the United States Federal Reserve, Ruchir Sharma argued that right now Chinese can earn the same interest rates in the United States for a lot less risk, so the motivation to flee is high, and will grow more intense as the Fed raises rates further.
President Erdogan has charged that the United States abetted by traitors and foreigners are waging economic warfare against Turkey, using a strong dollar as “the bullets, cannonballs and missiles.” Rejecting economic theory and wisdom, President Erdogan has sought for years to fight an alleged “interest rate lobby” that includes an ever-expanding number of financiers and foreign powers seeking to drive Turkish interest rates artificially high to damage the economy by insisting that low interest rates and borrowing costs would contain price hikes.
According to James Dorsey, in doing so, President Erdogan is harking back to an approach that was popular in Latin America in the 1960s and 1970s that may not be wholly wrong but similarly may also not be universally applicable. The European Bank for Reconstruction and Development (EBRD) warned late last year that Turkey’s “gross external financing needs to cover the current account deficit and external debt repayments due within a year are estimated at around 25% of GDP in 2017, leaving the country exposed to global liquidity conditions.”
James Dorsey further noted that with two international credit rating agencies reducing Turkish debt to junk status in the wake of Turkey’s economically fought disputes with the United States, the government risks its access to foreign credits being curtailed, which could force it to extract more money from ordinary Turks through increased taxes. That in turn would raise the spectre of recession.
Ruchir Sharma said “Turkey’s troubles are homegrown, and the economic war against it is a figment of Mr. Erdogan’s conspiratorial imagination. But he does have a point about the impact of a surging dollar, which has a long history of inflicting damage on developing nations.”
Nevertheless, as The Wall Street Journal concluded, the vulnerability of Turkey’s debt-driven growth was such that it only took two tweets by United States President Donald Trump announcing sanctions against two Turkish Ministers and the doubling of some tariffs to accelerate the Turkish lira’s tailspin.
According to James Dorsey, President Erdogan may not immediately draw the same conclusion, but it is certainly one that is likely to serve as a cautionary note for countries that see debt, whether domestic or associated with China’s infrastructure-driven Belt and Road initiative, as a main driver of growth.
It is instructive that Pakistan could in the next weeks be turning to the IMF for the 13th time. To date, Turkey has been forced to turn to the IMF for help 50% more, which is of course a total of 18 times.