Turkey: Effects of the lira crisis spreading

There is no end to the Turkish lira crisis – on the contrary! This morning, within the space of a few minutes more than 11% was wiped off the country’s currency against the US dollar. Following the losses of recent weeks, this, needless to say, resulted in the lira marking new record lows against the euro and the US dollar. The causes of the crisis are well known: a central bank failing to act, despite an escalating inflation rate and whose independence is more than questionable, and a Turkish President advocating dubious economic theses, warning against foreign conspirators and embarking on a foreign policy confrontation course with the USA. Yesterday’s attempt by the government – in the person of Erdogan’s son-in-law and finance minister – to counteract the crisis by revising down the growth estimates in the budget projections, came – not surprisingly – to nothing.

In the meantime, the effects of the lira’s nosedive are no longer confined to Turkey’s currency alone but are now also spreading to other currencies. This is particularly true of the South African rand which, in the last two days, lost more than 4% against the greenback without the reasons for this being attributable to decisive developments on the Cape. This morning, Europe’s single currency was also caught up in the lira crisis. Prior to this, reports that the European banking regulators were taking a closer look at the Turkish exposures of some institutions fuelled concerns about contagion effects on the local banking system.

Emerging market currencies faced with a difficult combination of factors

The fears currently emerging on the currency market about European banks, and by extension about the euro, are most likely to be overstated, as evidenced for example by the minimal fluctuations on the indices crucial for sentiment towards financial institutions. However, it is not only the crisis in Turkey that is currently casting a shadow over sentiment on the currency markets. The more restrictive alignment of the US Federal Reserve, the threat of a trade war between the world’s two largest economies and a US president who seems to have taken a liking to sanctions and tariffs – this combination is increasingly weighing on sentiment, especially regarding the emerging market currencies. In contrast, demand for safe havens such as the Japanese yen and the Swiss franc has not been as strong on currency markets for a long time.

Until now, the chances that the lira’s nosedive will not culminate in a crisis in the entire emerging market currency segment are generally good. We do not expect global trade disputes to escalate in the form of a genuine trade or currency war, nor are there any signs of a marked slump in global economic growth. The emerging market currencies of Eastern Europe, the Czech Republic, Hungary and Poland are also very strongly positioned economically.

But this does not by any means suggest that the lira will emerge unscathed from its current bout of weakness. In the early afternoon, both Turkey’s President Erdogan and his Finance Minister Albayrak are due to hold speeches. It should be interesting to see whether and to what extent both respond to developments on the financial markets. As things stand at the moment, we are unlikely to experience a change of heart. On the contrary, the head of state is more likely to continue talking above all about conspiracies on the part of foreign powers and making exhortations to stand firm. Against this backdrop, we are clearly unlikely to see an end to the lira crisis. This would require a credible, independent central bank and a far more restrictive monetary policy. Without such steps, the issue of default is also likely to move more into the focus of discussion sooner or later.

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