Why Turkey’s financial crisis matters for other countries
Investors are fretting about emerging markets again.
Turkey is the front-burner concern at the moment, but what really is getting people’s attention is the prospect that the financial problems there could spread to other fastgrowing, but risky, countries.
If history is any indication, that has the potential to quickly turn a local crisis into a global one. Or maybe not.
What’s happening in Turkey?
Over the past week, the value of the Turkish lira collapsed by more than 20 percent, shocking financial markets.
At first glance, this seems like a problem peculiar to Turkey.
The country’s economy has been weakening. At the same time, Turkey’s authoritarian president, Recep Tayyip Erdogan, has been seizing greater control over the country’s economic policy. He appointed his son-in-law as finance minister. He has made a series of pronouncements that undercut the independence of the country’s central bank, railing against the prospect of high interest rates.
Lower interest rates tend to stoke growth — as well as inflation. And Turkey is already dealing with inflation running near an annual rate of 16 percent.
Foreign investors are scared. They have been pulling money out of the country. In practice, that means that they sell lira and buy dollars or other currencies. The result is that the value of the lira has plunged. And that has the potential to upend the Turkish economy and financial system.
Why does this matter to the world?
Turkey’s economy isn’t all that large, so even if it were to collapse, that wouldn’t necessarily have a huge impact on the global economy.
But elements of the Turkish saga show how other financial markets could be vulnerable to a similar exodus of foreign investors.
In recent years, investors in wealthier parts of the world, like the United States, Europe and Japan, have lent many billions of dollars to governments and companies in developing economies like Turkey, South Africa and Argentina.
That has been an attractive proposition because interest rates in the United States and other developed markets have been incredibly low, as central banks tried to nurse their economies back to health after the last recession. The higher rates on offer in countries like Turkey have acted as magnets for foreign capital.
Now, with the economy of the United States strong again, the Federal Reserve has been raising interest rates. As a result, keeping money invested in U.S. markets looks like a better deal, and the dollar has strengthened.
The stronger dollar is bad news for foreign countries and companies that borrowed dollars. That’s because currency moves are always relative. If the dollar is up, that means other currencies are down, and vice versa. A stronger dollar therefore makes it more difficult for foreigners to pay back their dollar-based loans.
Turkey is far from the only country whose economy has grown reliant on foreign lending. Argentina and South Africa are in the same boat. That’s why some think that the problems underway in Turkey could be the start of something bigger.
How do problems spread?
In past crises, one way that trouble spread was through the banking system. Foreign banks lent money to companies, investors and governments in the crisis-stricken countries. As borrowers defaulted, those loans led to deep losses that threatened to undermine the health of financial systems thousands of miles away.
There are echoes of that situation in today’s Turkey crisis. A number of large European banks — including Italy’s UniCredit, Spain’s BBVA and France’s BNP Paribas — own stakes in Turkish lenders. Other western banks are exposed to Turkey via loans to Turkish companies.
Those banking losses might not look likely to presage a broader crisis. But if other emerging-market countries follow Turkey into trouble, the losses could worsen.