Currency crisis

Let’s call it what is: Turkey’s lira is in crisis. What does it mean and what can we do?

Dünya Executive - - COVER PAGE - by Mehmet Filoglu

1 Lets call it: Currency crisis

The depreciati­on of the Turkish lira since March has turned into a currency crisis in recent weeks. Over the last week, the devaluatio­n of the lira has surpassed 20 percent. The foreign exchange shortage position of Turkish private companies is around $220 billion. A significan­t portion of this figure is not hedged.

2 Contagion is imminent

Both the crisis Turkey had in the past and the crisis other developing countries are experienci­ng now indicate that the currency crisis will turn into a balance of payments and banking crisis within a few months. This will lead to the entire financial system being locked down and a severe contractio­n in the economy.

3 Total dollarizat­ion

The depreciati­on of the Turkish lira day by day will lead to more frequent use of internatio­nal currencies in business contracts. This will limit the policy making capacity of local decision-makers. Turkey has experience­d something similar in the 1990s. Much of the transactio­ns took place in foreign currencies, from renting houses to second-hand car sales.

4 Government’s approach

Eyes are now completely on the government and measures to be taken. On August 10, President Erdogan described the developmen­ts as an economic war on Turkey and invited citizens to change their dollars into TRY. According to Erdogan, Turkey is strong enough to win this ‘war’. On the other hand, the reserves of the country tell another story.

5 Debt-oriented view

One of the most common methods used to gauge the adequacy of a country’s reserves is to compare them with its upcoming debt payments, and by this yardstick Turkey stands out due to its large stack of foreign currency borrowings. That ratio dropped to just below 74 percent at the mid-year point, having started 2018 at about 90 percent.

6 Far from break-even level

Even that was low, as 100 percent is generally considered the minimum. In the simplest terms it means that without access to borrowing markets or without generating extra reserves, Turkey could in theory default. It needs to refinance around $200 billion a year on average.

7 IMF’s approach

The Internatio­nal Monetary Fund is seen as the oracle on currency crises due to its vast experience in trying to put countries’ finances back together. It has developed a broader gauge it calls the Reserve Adequacy Measure (RAM) which tries to capture the total resources a country has available to meet shocks.

8 RAM ratio falls for fifth consecutiv­e year

On top of the traditiona­l FX and gold reserves, it also takes into account central bank swap lines, sovereign wealth fund ammunition and access to IMF and other protective financing to calculate an overall ratio. The IMF’s rule of thumb is that a country’s RAM ratio should be between 100 and 150 percent. Turkey’s is now below 75 percent having dropped every year since 2013.

9 Debt to imports ratio

Another measure that some experts say is now overly simplistic is the amount of time that a country’s reserves would cover the costs of it imports. Turkey is a big energy importer, so in that sense it does have a particular relevance, especially when oil and gas prices are 50 percent higher than they were a year ago and still rising. Turkey’s manufactur­ing sector is also highly dependent on raw material imports.

10 It covers only 5 months imports

Three months’ import cover is typically seen as the lowest safe level. Turkey’s figure is currently around five months according to the most recent data, though it will drop rapidly if the lira doesn’t stabilize. However, this ratio can be higher too in near future as Turkish economy is slowing and it will reduce Turkey’s overall import bill.

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