A plummeting Turkish lira is raising fears of more widespread chaos given the size of Turkey’s economy, its strategically significant geographic position and its close ties to the Eurozone.

In this article we examine four key questions raised by this ongoing currency-led crisis.

WHY IS TURKEY’S CURRENCY FALLING?

Since the beginning of 2018 the lira has been weak thanks to rising inflation and substantial government borrowings but the sell-off has accelerated in August amid a dispute with the US and the currency is now down more than 40% year-to-date.

The Trump administration has imposed tariffs on imports from the country after Turkey’s detention of American pastor Andrew Brunson.

Turkish president Recep Tayyip Erdogan has resisted calls for an increase in interest rates despite inflation running wild and instead is blaming ‘economic terrorists’ and claiming his country has been stabbed in the back by Western allies.

WHY DOES IT MATTER TO YOU?

The question for investors is whether Turkey is a canary in the coal mine for a more significant financial crisis or an isolated case whose impact should largely be confined within Turkey’s borders. There has already been some contagion with the euro falling along with other emerging markets currencies.

WHAT HAS BEEN THE WIDER IMPACT SO FAR?

Many developing economies, like Turkey, have significant amounts of dollar-denominated debt. Rising US interest rates and a strong dollar are not helpful, and the Argentinian peso and South African rand are among the currencies which have fallen in the wake of the Turkish crisis.

Capital Economics’ markets economist Oliver Jones says: ‘Regardless of what happens next in Turkey, we remain fairly pessimistic about the medium-term outlook for EM currencies, particularly given our view that growth in China will slow further this year, and that the US economy will lose momentum in 2019.’

WHAT HAPPENS NEXT?

For the Eurozone the fear is that fragile Spanish and Italian banks could see losses thanks to exposure to bad debts in Turkey and that there could be a politically unpopular influx of Turkish immigration to the economic area.

Edison Investment Research chief strategist Alastair George says: ‘Outside Turkey the key risk in our view is a greater degree of spill-over to other relatively fragile regions of the world economy.

‘Fortunately in terms of direct exposures, the amounts appear to be relatively modest. Press reports indicate the ECB believes there is approximately $100bn of exposure to Turkey within the Eurozone banking system, which on the face of it is a manageable figure. However, the impact on investor sentiment could be a much more significant factor.’ (TS)

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