Why the Collapse of the Turkish Lira Matters

On Friday morning, the Turkish lira plunged by over 20% against the U.S. dollar, into record low territory, extending the currency’s spiraling decline of the past several years. The fall of the lira has accelerated dramatically in 2018, but Friday’s one-day collapse far eclipsed any previous slide.

Below is a daily chart of the U.S. dollar against the Turkish lira spanning a time frame of one year. Because the dollar is the first, or base, currency in the USD/TRY currency pair, the sharp rise on the chart illustrates the dramatic weakening of the lira against the dollar.

Source: TradingView

Severe economic and geopolitical troubles that have continued to plague Turkey combined on Friday to cause the exceptionally sharp currency moves.

Consistently deteriorating relations between the U.S. and Turkey over recent years have risen to alarming levels, dealing a severe blow to both Turkey’s economy and its currency.

Just last week, Washington announced new sanctions on Turkish officials in response to the detention of an American pastor accused of supporting a 2016 failed coup against Turkish President Recep Tayyip Erdogan.

Then, on Friday, just as the Turkish lira was in a state of free fall, U.S. President Donald Trump helped exacerbate Turkey’s problems by announcing dramatically increased tariffs on metal imports from Turkey.

Trump tweeted:

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!

— Donald J. Trump (@realDonaldTrump) August 10, 2018

The tweet served to place intensified pressure on the plummeting lira, despite President Erdogan’s attempts to limit the damage.

Concerns about rapidly rising inflation in Turkey – above 15% year-over-year in July – have not been addressed by corresponding hikes in interest rates by the country’s central bank. President Erdogan has pressured the central bank to maintain low interest rates by refraining from implementing much-needed hikes. An artificially low interest rate environment has contributed to additional ongoing pressures on the Turkish lira.

Turkey’s massive debt obligation to other countries is evident in the extraordinarily large percentage of its debt that is denominated in foreign currencies. As the lira continues to weaken, this foreign debt becomes increasingly difficult and expensive for Turkey to manage, which should further exacerbate the currency’s decline. A looming debt crisis that potentially involves a Turkish request for assistance or a bailout from the International Monetary Fund could have significant European and global economic repercussions. Turkey’s exceptionally large current account deficit makes the country’s potential to fall into a severe debt crisis even greater. That said, the global threat from Turkey's debt problems is relatively small. According to the Bank of International Settlements global exposure to Turkish loans is $265 billion, or less than 1% of the worldwide total. Still, a Turkish debt crisis could set off unknown consequences throughout the already volatile region.

President Erdogan tried to stem currency losses on Friday by urging Turkish citizens to fight the economic war against other countries and use foreign currencies and gold to buy lira. This attempt to generate national fervor in defense of the Turkish currency, however, was not immediately successful. The lira remained heavily pressured against the U.S. dollar well into Friday afternoon.

Aside from the impact a potential Turkish debt crisis may have on European markets and financial institutions, which could have a rippling effect on other global markets, the falling lira also matters because it helps to further depress an already-weakened euro and further strengthen the U.S. dollar, which has been rising sharply for much of this year.

As President Erdogan continues to exert an iron grip on the government, economy, and people of Turkey, and the specter of a Turkish debt crisis continues to loom, the country’s economy and currency are apt to remain under heavy pressure.