Question

explain the causes of the recent Turkish financial and economic crisis that started in 2018. What effect did it have on the Turkish economy and the global economy? What kind of fiscal and monetary policies were implemented by turkey? What are the challenges that remain for the Turkish economy? (1000 words)

Answer 1

During the emergence of the crisis, lenders in Turkey were hit by restructuring demands of corporations unable to serve their USD or EUR denominated debt, due to the loss of value of their earnings in Turkish lira. While financial institutions had been the driver of the Istanbul stock exchange for many years, accounting for almost half its value, by mid-April they accounted for less than one-third. By late-May, lenders were facing a surge in demand from companies seeking to reorganise debt repayments. By early-July, public restructuring requests by some of the country's biggest businesses alone already totalled $20,000,000,000 with other debtors not publicly listed or large enough to require disclosures. The asset quality of Turkish banks, as well as their capital adequacy ratio, kept deteriorating throughout the crisis. By June Halk Bankası, the most vulnerable of the large lenders, had lost 63% of its US dollar value since last summer and traded at 40% of book value. However, it is hard to say that this is mainly due to the economic developments in Turkey since the valuation of Halkbank was largely affected by the rumors over the possible outcomes of the US investigation about the bank's stated help Iran for evading US sanctions.
Banks continuously raised interest rates for business and consumer loans and mortgage loan rates, towards 20% annually, thus curbing demand from businesses and consumers. With a corresponding growth in deposits, the gap between total deposits and total loans, which had been one of the highest in emerging markets, began to narrow. However, this development has also led to unfinished or unoccupied housing and commercial real estate littering the outskirts of Turkey's major cities, as Erdoğan's policies had fuelled the construction sector, where many of his business allies are very active, to lead past economic growth. In March 2018, home sales fell 14% and mortgage sales declined 35% compared to a year earlier. As of May, Turkey had around 2,000,000 unsold houses, a backlog three times the size of the average annual number of new housing sales. In the first half of 2018, unsold stock of new housing kept increasing, while increases in new home prices in Turkey were lagging consumer price inflation by more than 10 percentage points.
While heavy portfolio capital outflows persisted, $883,000,000 in June, with official foreign exchange reserves declining by a $6,990,000,000 during June, the current account deficit started narrowing in June, due to the weakened exchange rate for the lira. This was perceived as a sign of getting balanced economy. Turkish Lira started recover its losses as of September 2018 and the current account deficit continued to shrink.
As a consequence of the earlier monetary policy of easy money, any newfound fragile short-term macroeconomic stability is based on higher interest rates, thus creating a recessionary effect for the Turkish economy. In mid-June, the Washington Post carried the quote from a senior financial figure in Istanbul that "years of irresponsible policies have overheated the Turkish economy. High inflation rates and current account deficits are going to prove sticky. I think we are at the end of our rope."

During the emergence of the crisis, lenders in Turkey were hit by restructuring demands of corporations unable to serve their USD or EUR denominated debt, due to the loss of value of their earnings in Turkish lira. While financial institutions had been the driver of the Istanbul stock exchange for many years, accounting for almost half its value, by mid-April they accounted for less than one-third. By late-May, lenders were facing a surge in demand from companies seeking to reorganise debt repayments. By early-July, public restructuring requests by some of the country's biggest businesses alone already totalled $20,000,000,000 with other debtors not publicly listed or large enough to require disclosures. The asset quality of Turkish banks, as well as their capital adequacy ratio, kept deteriorating throughout the crisis. By June Halk Bankası, the most vulnerable of the large lenders, had lost 63% of its US dollar value since last summer and traded at 40% of book value. However, it is hard to say that this is mainly due to the economic developments in Turkey since the valuation of Halkbank was largely affected by the rumors over the possible outcomes of the US investigation about the bank's stated help Iran for evading US sanctions.

Banks continuously raised interest rates for business and consumer loans and mortgage loan rates, towards 20% annually, thus curbing demand from businesses and consumers. With a corresponding growth in deposits, the gap between total deposits and total loans, which had been one of the highest in emerging markets, began to narrow. However, this development has also led to unfinished or unoccupied housing and commercial real estate littering the outskirts of Turkey's major cities, as Erdoğan's policies had fuelled the construction sector, where many of his business allies are very active, to lead past economic growth. In March 2018, home sales fell 14% and mortgage sales declined 35% compared to a year earlier. As of May, Turkey had around 2,000,000 unsold houses, a backlog three times the size of the average annual number of new housing sales. In the first half of 2018, unsold stock of new housing kept increasing, while increases in new home prices in Turkey were lagging consumer price inflation by more than 10 percentage points.

While heavy portfolio capital outflows persisted, $883,000,000 in June, with official foreign exchange reserves declining by a $6,990,000,000 during June, the current account deficit started narrowing in June, due to the weakened exchange rate for the lira. This was perceived as a sign of getting balanced economy. Turkish Lira started recover its losses as of September 2018 and the current account deficit continued to shrink.

As a consequence of the earlier monetary policy of easy money, any newfound fragile short-term macroeconomic stability is based on higher interest rates, thus creating a recessionary effect for the Turkish economy. In mid-June, the Washington Post carried the quote from a senior financial figure in Istanbul that "years of irresponsible policies have overheated the Turkish economy. High inflation rates and current account deficits are going to prove sticky. I think we are at the end of our rope."

International Consequences

The crisis has brought considerable risks of financial contagion. One aspect concerns risk to foreign lenders, where according to the Bank for International Settlements, international banks had outstanding loans of $224 billion to Turkish borrowers, including $83 billion from banks in Spain, $35 billion from banks in France, $18 billion from banks in Italy, $17 billion each from banks in the United States and in the United Kingdom, and $13 billion from banks in Germany.^[129][130] Another aspect concerns the situation of other emerging economies with high levels of debt denominated in USD or EUR, with respect to which Turkey may either be considered "a canary in the coalmine" or even by its crisis and the bad handling thereof increase international investors' retreat for increased perception of risk in such countries. On 31 May 2018, the Institute of Financial Research (IIF) reported that the Turkish crisis has already spread to Lebanon, Colombia and South Africa.

Turkey is coming out of yet another financial crisis. This one may not have been its own doing, but that has not reduced the pain. In fact Turkey was hit worse in many ways by the present crisis than in any of the previous instances of sudden stop in capital inflows. And this despite the admirable resilience of domestic banks and the dramatic cuts in interest rates that the central bank undertook. Unemployment reached historic heights and the drops in GDP and industrial output were exceptionally severe. Macroeconomic instability has long been the bane of Turkey’s economy. In the past the culprits were easy to identify. You could blame irresponsible monetary policies, unsustainable fiscal expenditures, poor financial regulation, or inconsistent exchange-rate policies. It is to the country’s credit that as it came out of the 2001 crisis Turkey succeeded to fix these traditional sources of fragility. Monetary policy is governed by an inflation targeting framework and an independent central bank. Fiscal policy has been generally restrained and the public debt-to GDP ratio stable or declining. Banks have strong balance sheets, and regulation and supervision are much tighter than before. The currency is afloat. When it comes to macroeconomic management, Turkey has adopted all the best practices. The crisis has demonstrated that a financially open economy has many sources of vulnerability. Even when a country does its homework, it remains at the mercy of developments in external financial markets. Crises and contagion are endemic to financial globalization. The world of finance does not always operate in a benign fashion. So lesson number one is that policy needs to guard not just against domestic shocks, but also shocks that emanate from financial instability elsewhere. This has important implications for the optimal degree of financial integration for middle-income countries like Turkey. In particular, it suggests that complete financial openness may not be the best policy. A counter-cyclical approach to the capital account—encouraging inflows when finance is scarce but discouraging them when finance is plentiful—deserves serious consideration.