Risks from Turkey’s Ongoing Financial Crisis

by Nathan Heath ’20, Senior Research Associate and Political Risk Analyst

The Turkish economy has faced significant challenges since the beginning of its debt and currency crisis in early 2018. President Erdogan’s economic policies dramatically increased the country’s account deficits, and the rolling 12-month deficit reached $51.6 billion by January 2018, while the corporate account deficit stood at $214 billion by the end of 2017. Because of Erdogan’s refusal to let the Central Bank of the Republic of Turkey make necessary interest rate adjustments, Turkey’s economy also faced nearly 12% inflation by October 2017, and the value of the lira plummeted to 7.0 TRY/1.0 USD by April 2018. Although the lira has regained some value (currently sitting at 5.75 TRY/1.0 USD), the country’s economy still suffers from poor macroeconomic management. Combined with political instability and trade conflict with the United States, Turkey’s financial mishandlings, unless counteracted by sound economic policies, will continue to undermine investor confidence in the country in the near future.  

Macroeconomic mismanagement has steadily plagued the Turkish economy since Erdogan’s election to the presidency in 2014. Erdogan’s government has responded to economic crisis with short-term policies heavily reliant on government intervention in the banking sector. In a recent example, the Turkish government decided to use $16.5 billion in profits and special reserves from the Central Bank to fund government spending and stymie a revenue slump. While interventions temporarily relieved pressure on the country’s banks, they have also prevented capital markets development and continued to increase the government deficit. Lack of structural reforms in the construction and energy sectors, both of which have accrued massive debts, is also hampering the economy’s recovery, along with lack of investment in other key sectors such as agriculture and manufacturing.

Turkey’s ongoing political volatility also remains a threat to the country’s financial well-being. Erdogan’s rule was imperiled by a July 2016 coup attempt following rising protests over restrictions of civil rights and liberties in Turkey, and although the coup was crushed, the challenge to his rule threatened Erdogan’s leadership. The president has cracked down not only on political freedoms but on economic freedoms as well, and these practices have not gone unnoticed by foreign investors. More than one election cycle has seen Erdogan and his affiliates emerge victorious, despite the existence of substantial questions about the legitimacy of their victory. Outside of concerns over the macroeconomic mismanagement and barriers to doing business in Turkey itself, potential investors also maintain concerns over the country’s investment climate given its proximity to regional conflict, particularly the Syrian Civil War.

Turkey’s policies have brought it into conflict with the United States on more than one occasion in the past several years, resulting in further damage to the country’s economy. The quarrel with the U.S. over Washington’s failure to extradite dissident cleric Fethullah Gülen, accused of helping engineer the July 2016 attempted coup, was only the first of several arguments between the two countries. Turkey’s detention of U.S. pastor Andrew Brunson in October 2016 led to Washington levying sanctions on the country, a factor that eventually helped prompt Brunson’s release. More recently, Turkey has purchased new S-400 missiles from Russia, despite its own role as a key NATO member with the second largest military in the alliance. The decision to purchase S-400 missiles has rankled the U.S. security sector, given Turkey’s longtime strategic role as a regional ally and NATO member key to balancing Russian interests and currently boasting the second largest military force in the alliance. The Trump administration has imposed tariffs on imported Turkish metals (although recently that tariff has been cut from 50% to 25%), a measure that has further weakened the lira. In response to these punitive measures, the Erdogan regime has promoted alternative trading arrangements for Turkey, promoting closer ties with countries such as Russia, China, and Iran.  

The economic shocks from Turkey’s macroeconomic mismanagement, political volatility, and tensions with the U.S. have increased risks for foreign direct investment in the country. Investors continue to be bullish on the dollar, which remains strong against the still-recovering lira (5.75 TRY/1.0 USD), a currency they remain wary of along with other unstable currencies such as the yuan and Argentinian peso. Similarly, investors are cautious about the Central Bank’s efforts to shore up the lira, along with decisions reached in March to impose capital controls. It is likely that as U.S. sanctions and tariffs are imposed on Turkey over the Erdogan regime’s pushback on U.S. interests such as the S-400 missile system purchase, investment prospects will decrease as profits fall on imports from Turkish metal companies.  

There are a few simple steps that the Erdogan regime could take to counteract Turkey’s economic woes and decrease investor risk, thus increasing prospects for renewed FDI. Turkey can make substantive structural reforms to the construction and energy sectors, which would lower the country’s accrued debt.  Investment in other key sectors such as agriculture and manufacturing would also help foster economic growth. Furthermore, Erdogan could relax his grip on the Central Bank, allowing it to keep interest rates at or closer to the recommended 24 percent rate instead of being forced lower to achieve short-term gains. The government could also implement more investor-friendly policies such as relaxation of capital controls, which would assure investors their cash is not trapped in the country. Finally, Turkey could attempt to shore up relations with the U.S. by striking a balance between its economic relationships with nations such as Russia while aligning with historic NATO goals.

Note: This article was completed in August 2019.

Photo credit: Ahval News