Causes of the Turkish crisis and possible solutions

Causes of the Turkish crisis and possible solutions

The Turkish lira has dropped by 66% since Erdogan been elected president in 2014, but the most interesting is that it fell by 31% since May 14, when he pledged to take monetary tasks in person. This is the root of the problem.

The reasons:

The reasons are spitted into two categories: political reasons and economic reasons:

– Let’s start with the economic factors:

The trade balance deficit, the budget deficit, and a decrease in the net cash reserves of the Central Bank of Turkey, which fell from more than double the cash inventory to the negative territory.

– The political factors:

Firstly the dismissal the former Minister of Finance, Mohammad Shimshik, one of the most vital economic figures in Turkey, and the appointment of Erdogan’s brother-in-law, as well as Erdogan’s intervene in the operations of the Central Bank by refusing any interest rates hikes, which led to foreign investors’ confidence reduction. And what exacerbated the problem is Turkey’s refusal to release the American pastor, and then the US responded by doubling tariffs. Erdogan also demanded that the Turks support the lira through the exchange of their foreign currency holdings. Finally, the European Central Bank’s decision to investigate the exposure of European banks to Turkey led to external panic.

The problem is serious and big. First, the size of the debt of the Turkish government and Turkish companies in foreign currencies constitutes 50% of the GDP, thus a drop of 25% in the Turkish lira will result in an equivalent increase in debt. The other reason is the large foreign exposure to Turkey as an open economy that was the reason for the euro’s fast drop.

Possible solutions:

There are classic solutions, namely the release of the American pastor that might ease the political tension with the United States. A substantial interest rates hike and the independence of the Turkish Central Bank and possibly request assistance from the IMF if needed.

But we all know that these solutions will probably be hard to be executed because Erdogan is stubborn and will not change his policy so quickly. Other possible solutions come through monetary policy easing by curbing spending and raising taxes.

There are still other financial solutions, such as increasing the supply of foreign currency and raising foreign exchange reserves. Reducing imports and trying to increase exports by finding new markets. Issuing bonds in local currency with exceptionally high returns, Tax exemptions on foreign investment for a limited period, and these solutions increase the foreign cash supply. Of course, it is also possible to work diplomatically with Turkey’s allies through many possibilities.

In general, I do not expect this issue to end up in bankruptcy or government default. Generally, the deposits of Turks in banks are 70% and this is reassuring.