Turkey is heading for a serious financial crisis

The Turkish censorship machine has started. Citizens who are critical of the economic crisis in their own country have to expect serious consequences since Monday at the latest. It has identified nearly 350 user accounts in social networks, in which the decay of the national currency Lira would be “commented in a provocative manner,” said the Interior Ministry. The progress of the currency and economic crisis can hardly influence the government of President Recep Tayyip Erdoğan. She continues to try to control public opinion.

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The loss of control since the significant crash of the lira on last Friday is no longer deniable. Turkey is heading for a serious financial crisis. The decline in the national currency continued on Monday at a rapid pace. The lira fell at times by twelve percent, insurance against a default by Turkey, an important crisis indicator, were as expensive as since 2009 not more. The Turkish stock market also fell to levels that existed nine years ago. “So that the lira can sustainably stabilize, President Erdoğan would have to rethink radically,” writes Ulrich Leuchtmann, currency expert at Commerzbank, in an analysis sent on Monday. “But it does not look like that afterwards.” Those responsible would not know how to end the crisis – that’s why it accelerates even more.

What also showed on Monday: The lira crisis will not remain a Turkish crisis. Consequences for foreign banks, for other emerging economies and economies of the Eurozone were clearly felt on Monday. With the lira declining, currencies and assets in other emerging markets came under pressure, while the dollar gained in value. The Russian ruble fell more than six percent last week, and the South African rand reached its lowest level since June 2016. The currencies of Mexico, Indonesia and India were also down significantly. Rising interest rates in the US and the prospect of medium-term monetary tightening in the eurozone had already weakened emerging market currencies: when capital flows out of these countries, it has a negative impact on their exchange rates. The Turkey crisis has accelerated this effect.

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The decline of the lira also hits the European markets. Especially bank shares lost in value, including the papers of Commerzbank and Deutscher Bank. However, the two major German banks are less affected by the lira crisis than the banks in Spain, France and Italy, which have invested more heavily in Turkey. The highest risk is borne by the second largest Spanish bank BBVA. They own 49% of the Garanti Group, the second largest Turkish bank.

However, a crisis in Turkey alone would probably not upset either Europe’s banks in general, or BBVA in particular. Most banks have their risk largely hedged, write the analysts of the US financial services provider Citigroup. Even if BBVA were to write off its entire Turkey deal, resulting in billions in losses, the bank’s existence would not be jeopardized. The situation also seems to be under control across Europe: if the Turkish economy were to collapse completely, the so-called “Common Equity Tier 1 ratio” of European banks would fall from 14.2% to 12.7% next year, according to the estimate. That would still be enough. “The danger of a conflagration I consider limited,” says Carsten Brzeski, chief economist of ING Diba. “While other emerging market currencies will be affected, the Turkish economy is not important enough internationally to trigger a major crisis.”

Since the beginning of the year, the lira has lost almost 50 percent in value

The Turkish central bank responded on Monday with emergency measures to support the domestic financial sector. From now on, the currency guardians pump more money into the market. That is, banks can lend large sums to the central bank: both Turkish lira and foreign currencies such as dollars and euros. The central bank pledged to provide ten billion lira, six billion dollars and gold. All steps would be taken to ensure financial stability.

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Since the beginning of the year, the lira has lost almost 50 percent in value, while the economy is highly indebted abroad: a fatal combination. For companies and households, the repayment of loans is significantly more expensive due to the weakness of their own currency. Turkish banks also need foreign currency to service short-term foreign loans. In recent days, many Turks have exchanged their savings in dollars or euros, which accelerated the loss of value of the lira.

Rumors that euro and dollar accounts could be converted by Turkish citizens into lira were countered by the government. The fear of this move has been strong ever since President Erdoğan called on his compatriots to convert their dollar holdings into lira. Only a few have followed this appeal. The international financial markets now expect the Turkish central bank to raise interest rates. This is necessary from a monetary policy perspective, as inflation in the country is extremely high; it is currently 16 percent. Erdoğan is so far, however, against interest rate hikes. Its increasing influence on the central bank is also an important reason for investors’ mistrust. However, if the central bank does not demonstrate soon enough that it can continue to act independently, the loss of confidence should accelerate further.