Dollar hit by Allah
"Remember, they have dollars, but we have the people, our right and Allah", - the Turkish President Rejip Erdogan was cheerful while addressing a gathering in Baiburt (North-Eastern Turkey) on Friday, 10 August. The lira had been depreciating all week long, and the Turkish government saw traces of an international conspiracy in the weak performance of its national currency.
A few hours later, U.S. President Donald Trump tweeted again: “I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!” That day, the Turkish lira dropped 18% in value, causing tension both domestically and internationally.
"Those who have dollars or gold stored under their matrasses are going to have to exchange them for liras at our banks. This is an internal national fight. This will be my people’s reaction to those who are engaging in an economic war with us”, - this was the recipe for rescuing the national economy suggested by the Turkish leader.
That being said, although the Turks are voting for Erdogan, they are also good at keeping count of their money. It’s Monday, 13 August. The worst day for the lira in recent years – the exchange rate fell to 7:1. There is a line of 10 people at a bank branch in central Izmir. All of the customers are looking to buy dollars.
"Just a few weeks ago I bought dollars at 4.9, now I would be lucky if I got it at 6.9", - complains Onder, a 35-year-old man. He says he wants to buy $1,000.
After looking at a few other bank branches, we were convinced that small lines in banks are a normal thing for Turkish cities nowadays. We didn’t manage to find any of those who followed their President’s advice and decided to dispose of foreign currency. But the overwhelming majority of people seemed to be on a mission to find dollars. Euro is not that attractive – the currency is also unstable.
Erdogan's religious fanaticism is not often shared by those who live in big cities of Western Turkey. “This rhetoric is for rural areas, it works there. There is a lot of non-Muslim population in Izmir, moreover, locals are used to doing business with foreigners. The Islamic fanaticism of Erdogan does not fit here”, - Onder tells me while waiting in line.
The President was mocked across social media after the speech about Allah. When Erdogan called for a boycott of American iPhones, encouraging people to buy homemade Vestel Venus smartphones, the social media erupted again, pointing to the fact that Erdogan himself is in fact a vivid iPhone user and his first address to the nation after the failed coup attempt he published through an iPhone.
America Is to Blame?
It might sound like a paradox, but even Turks living in big cities are convinced that the financial crisis was created by the imperialist America that wanted to get Turkey on its knees. Some are actually saying that if Erdogan does not free Andrew Branson, a pastor who is being charged with terrorism, then the U.S. will bomb Turkey. Some people have admitted they had stored emergency food supplies at home “just in case”.
The Turkish media are bashing the United States all day long, suggesting a U.S. conspiracy against Turkey. Even CNN Turkey is telling its viewers how the United States are going to lose after losing Turkey. It is not often that Erdogan’s approach to the administration of the national economy is criticized here.
"People have always complained about prices. But they ended up voting for Erdogan nonetheless. Now they are complaining again. I call such people sheep, but even sheep are more clever. When it rains they go into the barn, not under a tree. Those people are dumber than sheep. They have voted for him time and time again”, - says Zerrin, a former nurse.
Turkey’s relatively high inflation in recent years is the price the country has to pay for its rapid economic expansion. After the 2008 financial crisis, the Turkish economy enjoyed steady growth. At the same time, the U.S. pursued the policy of flooding the economy with cheap unsubstantiated dollars, which caused many investors to turn to emerging markets instead. Foreign banks had been investing in the Turkish economy, causing it to grow dramatically from 2009 onwards. The country’s National Bank lowered the interest rate and maintained it at the level of 4.5-8%, thereby flooding the economy with cheap loans. Yes, Turkey’s GDP exhibited an impressive 7.4% expansion in 2017, which was greater than any other G-20 nation. But there is another side to this. Some experts have been talking about the Turkish economy overheating over the recent years. At the same time, the national government is denying this and refusing to interfere.
In just seven years, the Turkish government managed to triple the money supply. The inflation became the natural consequence of this policy. While enjoying a 7.4% growth in 2017, the Turkish government was exposed to a 10.9% inflation, which had not been recorded since 2009. It does not seem so surprising now, when inflation hit 15% in June of this year.
The national currency has been depreciating in the meantime, at an increasing pace recently. In January 2014, one could buy a U.S. dollar for 2 liras, in January 2018 it was priced at 3.77. The depreciation of the lira was not just ignored by the government but also encouraged. At the same time, the government kept boosting the volume of subsidies in order to maintain public support.
The combination of devaluation and inflation are eating up the Turkish people's incomes. For example, as of 2018, the minimum wage in Turkey is around 2,000 liras. At the start of 2018, that was equivalent to $550, now – to $350.
“Just at the beginning of this year, my salary was equivalent to $1,500, which is considered a rather good amount around here. Now it is closer to $1,000”, - says Ela, who is a teacher in Izmir.
Analysts are warning that the inflation is going to accelerate due to lira's drastic devaluation, which means disproportionately high risks for the poor and the middle class. Ukraine has been through a similar situation at one point. Atilla Yeshilada, a financial consultant at Global Source, a consulting firm, says that inflation is unlikely to be lower than 15% in the coming months. Every 10% of lira’s depreciation is responsible for an extra 2% inflation, - he says. – The inflation is likely to reach 20%. That is equivalent to a loss of a third of one’s salary – that means huge losses for people”.
The high inflation led to an increase in interest rates offered by banks on domestic loans. This is why Turkish corporations have been borrowing cheaply in the European Union. And the cumulative amount of such loans issued in Europe reached $200 billion denominated in euro and dollar. Turkish companies have to pay back their loans in foreign currency while their revenue is in lira. The lira’s devaluation may even lead to bankruptcy for many of them.
“My partner is going to fire 15 employees from his business, which is a third of his total staff. All our equipment is purchased in Europe with foreign currency. If lira falls even further, it is going to make the foreclosure of a business or the search for alternative shipments more attractive”, - says Can, the co-founder of a company engaged in the maintenance of Turkish factories.
Erdogan's eternal construction
In reality, a Erdogan's administration bears a lot of responsibilty for this financial crisis. Kevin Hassett, the Chairman of the Council of Economic Advisers of the United States came forward yesterday to claim that the double tariffs on Turkish metals implemented by President Trump account for just “a tiny portion” of the country’s GDP, which means that the continuing depreciation of the Turkish currency suggests the presence of fundamental economic problems in the country. “Whenever a country loses touch with liberal democracy, then you don’t know what is going to happen to the economy further down the line, and I believe there is a great degree of uncertainty”, - Hassett added.
The problem lies in Erdogan's populism, which he has transferred from politics to the economy. The rapid economic growth, accompanied by the creation of jobs and rising employment numbers, are what matters most to the Turkish leader. The employment numbers, by the way, are rather modest in Turkey – around 11-12% of the country’s workforce are unemployed. In this, Erdogan sees an opportunity to be gain success come election time. This is why after the 2008 financial crisis, the government’s division responsible for finance decided to focus on injecting the economy with cheap money and on infrastructure development. The drawbacks of this approach could be concealed as long as there was funding, but the situation changed once the sources of financing began growing ever scarcer.
The Trump administration has begun raising the key policy rate in order to encourage investors to return to the United States. The rates are rising, which means that investors are more willing to divert from rewarding, yet risky assets in developing nations, and turning to the reliable dollar treasuries instead. Oil is also becoming more expensive, meaning that Turkey, where natural resources are rather scarce, requires even more foreign currency in order to import energy from overseas. Erdogan has criticized the U.S. Federal Reserve’s decision to raise the interest rate a number of times.
Erdogan’s populist infrastructure policy has led to a situation with a multitude of concession-based infrastructure projects with state securities throughout the country. Bridges, airports and hospitals – all of these facilities managed by private operators (which are often tied to members of the government” were able to acquire state securities. According to Yilmaz Ozdil who wrote for Sözcü, the situation was the following: “Turkey’s fourth largest airport, Zafer, was constructed in Kütahya. It was reported at the time that not a single penny from the taxpayer’s pocket went towards the construction cost. There are some 200,000 people living in Kütahya. The contractor was given securities to 1 million passengers annually. It was claimed that the facility would be used by the inhabitants of the neighboring provinces of Afyon and Uşak. In 4 years of its existence the airport managed to provide services to just 170,000 passengers. Despite this, the contractor was promptly compensated for the remaining 3,800,000 non-existent customers. The concession for the friendly contractor will remain in effect until 2044, meaning it will continue receiving guaranteed payments from the state budget for another 26 years”.
In his article, Ozdil provides many more striking examples of such practices. “And now they are trying to convince us that this is not the result of the “brilliant” economic policy, but is because of some priest (meaning the American pastor Andrew Branson – 112.ua). It seems like we are going to be forced to pay for the church also, even though none of us are using it (hinting Erdogan’s religious fanaticism, - 112.ua)”, - the journalist writes.
Foreign investors are also skeptical of the degree of independence available to the National Bank of Turkey. Whenever inflation accelerates and national currency weakens, regulators tend to raise interest rates. Expensive loans curb financial activity, and the currency returns to stability. However, the increased interest rate will undoubtedly affect the GDP dynamics, which is the most fundamental aspect for Erdogan. In May, Erdogan referred to interest rate as “the mother and father of all evil”. A month earlier, he criticized the Bank of Turkey for raising the key policy rate as a reaction to the drop in the value of the lira. According to the President, the central bank cannot ignore the signals it observed during the election. “I am going to take full responsibility for taking decisive measures as the undisputed leader of the executive branch of the national government”, - Erdogan said in spring. He ended up winning the election, however, when the lira began its sharp decline, the President had no other choice but to agree with the central bank and raise the interest rate to 17.5%. Nevertheless, the decision came too late. On Monday, 13 August, the lira fell to as low as 7/1, having exhibited a 40% drop in year-over-year terms. Venezuela, with its infamous hyperinflation, could be the only other country that has it worse than Turkey.
Investors are growing more and more skeptical in regards to whether or not the country's government is indeed capable of effectively responding to the crisis, given Erdogan’s strive for building up his authority, his willingness to destroy public institutions, his intolerance towards those who criticize him, as well as the fact that the entire economic policy of the republic was delegated to the president’s son-in-law.
Turkey believes in Putin
So far, Erdogan is only adding to those doubts. When the lira began its downward flight, investors expected to see a stabilization plan from the country's government. Instead, Erdogam started a well familiar story about how the attack against his country had been rigorously planned in advance and is nothing but “a shot in the back”. At the same time, Turkish law enforcement agencies started investigating thousands of publications across social media claiming those who published such materials were partially responsible for bringing the lira down through “fake news”. The president even called them “economic terrorists”. This is obviously insufficient to calm down the markets.
The Turkish government refuses to raise the interest rate, while Erdogan referred to it as a "exploitation tool" not too long ago. The country’s regulator later announced a limit on currency transactions between domestic banks and foreign counteragents, particularly, regarding swaps and forward agreements. Such transactions cannot exceed 50% of the bank’s capital. The regulator also lowered the requirements towards the reserves of commercial banks it currently stores, in order to prop up the liquidity on the financial market. Some $10 billion were injected from the reserves onto the market. It produced a limited result. As of the morning of 15 August, the lira climbed to 6.08 per U.S. dollar. Although market actors continue withdrawing funds from Turkey, as they fear that restrictions on capital movement may be the policy the government ends up pursuing.
The sanctions recently introduced by Erdogan against the United States are likely to hit Turkey itself more, as the trade turnover between the two nations is not significant, but it was indeed Turkey that enjoyed a 30% growth in exports to the United States last year.
It is unclear how Erdogan intends to solve the problem of the trade deficit that reached $60 billion last year, and was mostly covered by foreign loans.
People in Turkey are counting on Russia. The media is discussing Vladimir Putin’s assurances to increase the tourist flow from Russia to Turkey (it is interesting how that would work out – as the rouble continues losing value too). Turkey’s tourism industry is now recovering after a difficult period. In 2014, a record-breaking 41.2 million people visited Turkey, but the number of tourists actually fell to 25.3 million in 2016 after multiple terrorist attacks, the attempted coup-d-etat, persisting political instability and confrontation with Russia. The bilateral relations between Russia and Turkey became warmer, which led to the tourism industry’s recovery last year, when a total of 32.4 million individuals visited the nation. However, the industry is under a sever threat from the devaluation and inflation.
The fall in the lira exchange rate means higher cost of financing the debt, it creates anticipation for a default and facilitates further outflow of capital from the Turkish economy. The country’s credit rating is now worse than that of Greece, while the bonds issued by large banks now promise a 20% return. The return on 10-year Turkish government bonds has reached 8.4%.
However, Erdogan is trying to play the situation to his advantage by reinforcing the nationalist rhetoric. The media showed photographs of people gathering in lines at currency exchange offices, where they were bringing their dollars to, some burnt their dollars for the camera. But this is more like propaganda than a mirror of reality.
Also, Erdogan is apparently going to divert the public eye away from the economic problems with a small war. Recently he announced that Turkey is about to finish preparing for a new operation in Syria.
Is the Turkish crisis dangerous for the world?
As Turkish banks and businesses have borrowed extensively in the European Union, the collapse of the Turkish economy may be another shock for the Eurozone. According to the Washington Post, dollar-denominated loans in Turkey account for circa 30% of the GDP, whereas loans in euros make up another 20% of the country’s gross domestic product. Also, the country’s debt in foreign currency is now at 50% of the GDP, or $181 billion, according to the International Monetary Fund.
Goldman Sachs has warned that the fall of the lira against the dollar to 7.2 per $1 would facilitate bankruptcy of the Turkish banking system. Even if this apocalyptic scenario is disregarded, the euro exchange rate has dropped.
The thing is that European banks have invested a lot of money in this country. According to the data from BIS, the Bank for International Settlements, Turkey has obtained $83 billion worth of loans from Spanish banks, $38 billion from French banks, $19 billion from the United Kingdom and $17 billion from Italy. This means that the crisis-prone Spain and Italy may require assistance from the European Central Banks if the crisis does not get resolved.
This is why Europe, despite political disagreements, is going to have to come to rescue Turkey. That is the paradox, as that would allow Erdogan to solidify his authority further with the help of Europe and the imbalances in the economy will grow even further. If the European Union refuses to rescue Turkey, the Greek scenario may happen once again. Theoretically, experts do not exclude another global financial crisis.
"No one wins from economic destabilization in Turkey. However, everything should be done to guarantee the independence of the central bank”, - German chancellor Angela Merkel said when the euro hit a 13-month low on currency markets.
Turkey's currency reserves are not that significant, if they are to be compared to the size of its economy and the debt - $80 billion in total. Ankara may need to turn to the IMF for support, but that would be interesting to see, as Erdogan is an outspoken critic of the fund and its recommendations. “Erdogan will do everything to prevent having to seek assistance from the IMF, as those would require the Turkish government to introduce austerity measures. That would be a huge political loss for Erdogan”, - says Karsten Gesse, an economist from Barenberg.
The Turkish crisis strengthens the concerns of the investors that had invested their funds in emerging economies, facilitating their outflow from Russia, Brazil, South Africa and India. Those countries’ national currencies have also become weaker over the last days.
Because of this, Erdogan has announced Turkey would pay its key trade allies such as Ukraine, Russia, China and Iran in national currency.
Erdogan could also become friendly with Trump again, but as of right now the rhetoric used by the Turkish president is still aggressive. He is inclined towards a partnership with Russia, China and Iran – countries that are not friendly with the United States. Experts have also discussed the possibility of Turkey pulling out of NATO.
What's up with Turkish resorts now?
Ukrainians are probably interested in the ways the lira devaluation is going to affect vacations in Turkey. One shouldn’t count on them becoming a lot cheaper. “The fall of the lira is not going to affect the prices of vacation tours to Turkey in any way, as the main agreements between Ukrainian tour operators and Turkish hotel owners are concluded in euro or dollars. The vacation season is coming to its end, new agreements are expected to be concluded around November or December. In theory, if the lira continues falling, this might affect the agreements for next year”, - said Oleksandr Novikovsky, the general manager of Tez Tour.
Also, one needs to take into account the fact that the lira devaluation will bring about increased fuel costs, energy costs, greater salaries, which is why hotel operators are likely to raise their prices over time.
Volodymyr Tsaruk, the director of the Center for Tourism development, says that as the result of the currency devaluation, only special promotions or discounts caused by low occupancy are likely to be on offer.
"But as this season for Turkey is rather successful, it is not very likely. Many hotels, for the first time in a long while, are on so-called “stop-lists”, which means they are not available for bookings. This is especially true of 5-star and over branded hotels. The lira devaluation may be useful for Ukrainian tourists only in regards to purchasing local Turkish goods and services”, - Tsaruk pointed out.