Currency Economics: The Collapsing Turkish Lira

The Turkish lira has collapsed losing more than 50 per cent of its value against the US dollar in just a few months.

In this video we explore some of the main causes of this and examine a range of short and possible medium-term outcomes when a country suffers such a steep depreciation in the external value of their exchange rate. When a currency drops so quickly and so much, this creates much economic and financial instability.

A modest competitive depreciation can help rebalance an economy and drive export growth. But will the drop in the lira threaten economic and political stability in Turkey?

Turkey has a population of 89 million people and accounts for just under 2 per cent of global GDP (PPP adjusted).

Turkey is a middle-income country that is outside the EU but operates within the EU’s customs union.

Turkey is one of the top-20 countries in the world measured by GDP and a top-30 country for exporting. So the collapse in the external value of their currency is BIG economic news with ramifications for other countries. This video is really useful context for your Year 13 macro exams.

The Turkish lira has been depreciating against the US dollar for several years, but the speed of the fall in the external value of the lira has gathered pace since the start of the pandemic.

The lira has slumped 48% against the dollar during 2021 and is the worst-performing currency in emerging markets.

Turkey operates a managed floating exchange rate. The Turkish central bank has been intervening in the currency markets on a regular basis in recent months to in a bid to support the lira. This has involved selling their foreign currency reserves and buying Turkish lira in exchange.

The dramatic collapse in the lira is in large part the result of President Erdogan’s “unconventional” monetary policy stimulus. To combat rising inflation, has told theTurkish Central Bank to cutinterest rates arguing that a competitive currency that will boost Turkish exports, attract foreign direct investment and create employment.

What are some of the positive macro effects of a falling currency?

• The most obvious benefit is on the value of Turkish exports
• A weaker currency makes Turkish exporters more price competitive in overseas markets including the European Union
• Exports are driving economic growth in Turkey with real GDP forecast to rise by 7% in 2021
• Some producers in EU and the USA have shifted some of their FDI to Turkey – benefitting from proximity to EU and Asian markets and Turkey having a competitive currency

What are some of the negative macro effects of a depreciating currency?

• Falling lira has caused spiraling inflation -Turkey is heavily reliant on imported energy and raw materials. Inflation is above 20% and rising.
• Real incomes are declining, and savers are facing severely negative real interest rates on their bank deposits.
• Turkey’s credit ratings have worsened – a reflection of the increased risk of investing in Turkey given high inflation. This makes it more expensive for Turkish businesses and the government to borrow
• There is evidence of a virtual brain drain among many young people

Many younger Turkish workers have migrated in search of better job opportunities and higher pay and living standards. A virtual brain drain is when Turkish people stay in the country but take work with overseas businesses such as tech start-ups who pay them in US dollars. As the Turkish lira falls, the valueof the US dollar earnings increase.

Perhaps the biggest risk for Turkey is that people will lose faith in the Turkish lira as a store of value amid sharply rising inflation. Millions may opt to withdraw their money from the banking system prompting a run on commercial banks and a financial crisis such as that afflicting Argentina and Venezuela.

Although Turkish real GDP growth is strong relative to other emerging countries (growth of 6-8% is forecast for 2021), GDP per capita measured in US dollar terms has fallen since 2013, dropping by almost USD4,000 to a forecast USD8,500 in 2021, due to the multi-year weakening of the currency.

The collapse in the Turkish lira is one of the most important economic stories around now. Young people are suffering with high unemployment and a dramatic fall in their real purchasing power. Many want to leave. Relative poverty is increasing since inflation in the prices of everyday items is having a regressive effect on the distribution of income.