Fears of Turkish financial crisis as Erdogan increases grip over economy

Turkey’s Lira and stock markets took a hit this week following the announcement of President Erdogan’s son-in-law as the powerful new treasury and finance Minister. According to the New York Times, the loss of independence of crucial government institutions, coupled with reckless economic policy, could place Turkey at growing risk of a financial crisis.

As reported in the Financial Times, the benchmark Borsa Istanbul 100 stock index was down more then 5 per cent on Wednesday. Turkish bank stocks were down 9 per cent as lenders feared an increase in bad debts if companies struggle to service dollar and euro dominated loans. The spread on Turkey’s 10-year dollar bonds rose to 4.48 per cent above the equivalent US Treasury, increasing from from 4 per cent on Monday and 3.37 per cent in April. The larger gap indicates an increasing risk premium required by investors.  

At 7.4 per cent GDP growth last year, Turkey’s economy is one of the fastest growing in the world. This has been achieved, however, through unrestrained borrowing which left debt levels extremely high. The government has subsidised huge infrastructure projects and companies have borrowed money in foreign currencies which has caused their debts to increase as the Lira drops.  

New current account deficit data released on Wednesday showed a deficit of US $5.89 billion in May, increasing from US$5.45 billion in April and US $5.37 billion in May last year. To fund this current account deficit and its maturing debts, Turkey needs to get approximately US $200 billion a year in foreign financing. This will prove difficult, however, as investors are concerned that Erdogan – who was sworn in again on Monday after an election victory that gave him extraordinary new powers – will have an even greater say in economic and monetary policy.

Erdogan has an unorthodox view on interest rates, thinking that lowering interest rates will bring down inflation, which is now at more than 15 per cent, according to Bloomberg. There are fears that without someone to keep the economy on a sustainable path, lowering interest rates and an even more unrestrained economic policy will lead to higher debts, increased investor reluctance, soaring inflation and ultimately an unsustainable current account deficit.