Aug 19, 2018 11:49 AM

Turkey’s Lessons for Emerging Economies

The IMF projected Turkey’s economic growth to slow to 4% this year from 7% last year. Photo: VCG
The IMF projected Turkey’s economic growth to slow to 4% this year from 7% last year. Photo: VCG

* The turmoil in Turkey is a clear warning for emerging economies that share some of Turkey’s economic features — low savings rate, heavy reliance on foreign borrowing and high inflation

* For Turkey, an urgent issue is to restore investor confidence

Not that long ago, Turkey’s emerging economy was the darling of global investors.

Robust growth driven by massive investments and construction tripled Turkey’s per capita GDP in 15 years and made it the world’s 17th largest economy.

But now the glory days are over. Turkey has become a textbook example of how debt-fueled growth can lead to a currency crisis that rattles global markets.

A spending spree relying on foreign borrowing built up external debts totaling $466.7 billion, or more than 53% of Turkey’s GDP. Inflation surged over 15% in June, the highest since rate 2004. And the nation’s current-account deficit – a measure of imports, exports and investment flows – reached 5.6% of GDP, greater than that of any other country in the Group of 20.

A deepening rift with the U.S. is adding to Turkey’s troubles. On Aug. 10, President Donald Trump announced a doubling of tariffs on Turkish metals, setting of a collapse of the Turkish currency, the lira. The currency weakened 17% that day and has lost nearly 40% of its value against the dollar so far this year.

Zan Tao, a professor of Turkey studies at Peking University, said that after years of upbeat views on the Turkish economy, market confidence has been dented as Turkey drifts away from the western countries, especially the U.S.

The crash of the lira has sent ripples through global markets, putting more pressure on the euro and increasing investors’ risk aversion to emerging-market currencies across the board. On Aug. 13, South Africa’s rand slumped nearly 10%, the biggest daily drop since June 2016. The Russian ruble has accelerated a decline to lose more than 10% against the dollar so far this month.

The Chinese yuan, which was already under pressure amid the trade war with the U.S., also felt the chill from Turkey as investors moved to safe-haven currencies like the dollar. The yuan has lost nearly 7% against the dollar over the past two month.

To many, the turmoil in Turkey is a clear warning for emerging economies that share some of Turkey’s economic features — low savings rate, heavy reliance on foreign borrowing and high inflation. For instance, Hungary, Argentina, Poland and Chile face similar challenges to contain high external debts that amount more half of their respective GDP, according to data from Deutsche Bank.

In China, regulators have applied strong measures over the past few years to prevent public and corporate debt from getting out of hand. But Chinese regulators have more room for maneuvre as the country’s savings rate is at a relatively high level of more than 40%, and inflation is just slightly over 2%.

Credit bubble

Things went wild as the lira nosedived following Trump’s Aug. 10 tweet about doubling tariffs on Turkish steel and aluminum. Luxury products stores in Istanbul were filled with tourists and shoppers hunting for Chanel and Louis Vuitton as the foreign brands were suddenly a lot of cheaper. Far away in China, the leading online travel booking site Ctrip quickly shut down the lira payment option to prevent users from exploiting the currency’s fluctuation by paying in lira and asking for refunds in yuan.

But for economists and investors, the sudden currency crisis spotlighted deeper concerns about the Turkish economy that have long signaled turmoil.

Turkey’s economic boom started in the early 2000s after the country recovered from a previous debt crisis and embraced reforms to cut public debt and strengthen supervision of the banking sector.

President Recep Tayyip Erdogan pressed banks to maintain low interest rates for years to encourage investment and consumption. Since 2014, the Turkish government has stepped up economic stimulus with heavy investment in infrastructure. In less than four years, the size of Turkey’s highway system quadrupled, along with 1,000 kilometers of newly built high-speed rail lines. The number of airports doubled to more than 50. In 2017, Turkey’s per capita GDP hit $10,000, nearly triple the 2002 figure.

But Turkey’s savings rate has remained at an unusually low level in the environment of low interest rates. According to the World Bank, Turkey’s savings rate held below 20% since 2000. By contrast, China’s savings rate was 46% in 2008 when the country started major stimulus to boost growth.

Businesses borrowed heavily in foreign currencies. According to the International Monetary Fund, Turkey’s external debts accounted for 53.3% of nominal GDP in 2017, rising from 46.9% the previous year. About 90% of Turkey’s external debts are in foreign currencies. The country’s foreign exchange reserves, which amounted to $74 billion in June, can barely cover 90% of the debts that are set to come due this year.

As spending boomed, the current-account deficit expanded. While investing heavily in property, construction and infrastructure, Turkish companies haven’t contributed much to the economy in the way of exports and production, according to Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington.

The IMF in February warned of the danger to Turkey’s economy.

“Vulnerabilities include large external financing needs, limited foreign exchange reserves, increased reliance on short-term capital inflows, and high corporate exposure to foreign exchange risk,” the fund said in a statement. The IMF projected Turkey’s economic growth to slow to 4% this year from 7% last year.

Finding therapy

The Turkish government has taken some steps to stem the lira’s plunge such as easing capital requirements on banks and limiting swap transactions to make it harder to short-sell the currency.

Some external supports have also been pledged. On Aug. 15, Qatar announced it would invest $15 billion in Turkey. Russia agreed to use the lira for settlements in bilateral trade instead of the dollar. And Turkish media reported that China’s state-run Industrial and Commercial Bank of China signed a $3.8 billion financing agreement with Turkey in late July.

On Friday, China’s Foreign Affairs Ministry said the country has always supported business and financial cooperation between China and Turkey in accordance with market rules, referring to the ICBC deal.

The news led to a mild rally for the lira. But economists and market observers have called for more drastic monetary measures from the Turkish government to ride out the crisis.

Economists said the most effective way for Turkey to contain the crisis would be to raise interest rates. Simon Derrick, chief strategist at BNY Mellon, said the market has expected a rate increase in Turkey since the beginning of this year when the lira started to decline. Turkey should lift the rate by 5 to 6 percentage points to ensure the policy is powerful enough, Derrick said.

But Turkey has yet to adjust its interest rates, partly reflecting Erdogan’s distaste for higher rates. Turkey’s benchmark interest rate has remained 17.75% since early June.

Some have suggested that Turkey seek a bailout from the IMF, but that may not be acceptable for Erdogan, who has advocated ending dependency on the fund. The IMF told Caixin that the Turkish government hadn’t approached the fund for any assistance as of Aug. 13.

One most likely scenario for Turkey is to get a helping hand from the European Union, its largest trading partner, several economists told Caixin. The EU accounted for nearly half of Turkey’s exports and two-thirds of foreign direct investment in the country in 2017.

There are fears that Turkey’s crisis could spill over to the eurozone. Banks in eurozone countries, mostly in Spain, France and Italy, accounted for 75% of Turkey’s $223 billion in foreign debts by the end of the first quarter.

But economists said the spillover should be limited. John Higgins, market economist at Capital Economics, said in a research note that “neither the overall exposure of banks in the eurozone to Turkey nor the direct links between the region’s economy and the country is large.”

For Turkey, an urgent issue is to restore investor confidence. If investor sentiment further weakens and they continue sell off the lira, the currency will plunge further.

“It will be the last straw that would break the camel's back,” said Steve Hanke, an applied economics professor at Johns Hopkins University.

Contact reporter Han Wei (

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