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Group 45
Akanksha Yadav PGP-18-169
Ankita Bhardwaj PGP-18-175
Dhiren Gala PGP-18-185
Jugal Popat PGP-18-194
Varun Singh PGP-18-234

What caused a country that was ranked 8th in the top 20 Developing Debtor Countries (World
Bank, International Debt Statistics, 2018), with an external debt to equity ratio of only 47.8% and
touted as one of the fastest growing G20 economies in 2017 to slip and become one the biggest
villains in the story of global growth by 2018? The Turkish currency Lira has been sinking since
January 2018 and till date, has lost almost 34% of its value against US dollars and has become the
worst performing currency in 2018. The Indian rupee also plunged to an all-time low and has been
trading at around Rs. 70 per dollar.

Lead Up to the Crisis

Turkey experienced an economic boom between 2002 and 2007 where the country's economy
grew at an annual rate of 7.2%, also performing relatively well throughout the global financial
crisis: after a slowdown in GDP growth to just 0.6% in 2008 and a later recession (which saw a
4.6% reduction in GDP).
The economy strongly rebounded, producing 8.8% growth in 2010 and 9.2% in 2011 but the
risks associated with a series of unresolved issues were becoming increasingly apparent which
encompassed the country’s CAD, its over-reliance on short-term external financing, and
unfinished reforms, like in the education sector.
This left Turkey exposed to over-dependence on investors, especially from the West in essence,
Ankara had become a hostage of its own image as an economically successful state with a stable
socio-political system. The Turkish economy has been characterized by low savings rate and has
traditionally suffered from a large current account deficit. It is caused by, among other factors,
a high level of imports, mainly from the country’s dependence on imported energy carriers (for
eg., in 2012, the cost of energy imports made up 25% of the total value of imports), as well as
by a high %age of imported intermediates used for the production of Turkish export goods - which
means that export growth means an increase in imports. The deficit is also a result of Turkey’s
high domestic consumption (a rise in industrial production increases imports), which is
accentuated by easily available consumer credit.
All in all, have always been dependent on foreign inflows for filling the gap between imports and
exports thereby making it extremely vulnerable to external conditions like sanctions and pressures.
The external funds were used to finance massive government spending, fiscal deficits, and

How the Crisis unfolded?

Investment inflows were already declining in the time leading up to the crisis, owing to the
president fueling political disagreements with countries that were major sources of investment
inflows such as Germany, France, and the Netherlands.
The recent cause of major concern has been amplified by the Turkish President’s economic policy.
For most of the countries, including the US and EU states, the central bank is independent of
government’s influence and is solely responsible for what to do with interest rates, which means
that it can keep control of inflation by raising them when necessary. While in case of Turkey, the
president has taken control of the reins by claiming the exclusive power to appoint the bankers
that set interest rates in a way to cement his control and in his pursuit to put his son-in-law in
charge of economic policy.
As the crisis emerged, lenders in Turkey were hit by restructuring demands of corporations unable
to serve their USD or EUR denominated debt, due to the loss of value of their earnings in Turkish
lira. Even though financial institutions had been the driver of the Istanbul stock exchange for many
years, contributing almost half its value, by April 2018 they accounted for less than one-third. By
May-end, lenders were facing a surge in demand from companies seeking to reorganize debt
As of June 2018 Turkey imported $18.4B of goods while exporting about $13B. So they are in a
balance of trade deficit of less than 1 % of GDP of $851B, which is worrying but a manageable
crisis. However, the country is running high on inflation, interest rate, and external debt. With
persistent double-digit inflation currently at 15.85 %, the interest rate at 17.75 % and with
an unemployment rate of 9.7%, is making the situation much more volatile.
By the start of July, public restructuring requests by some of the country’s biggest businesses
already totaled $20B with other debtors not publicly listed or large enough to require disclosures.
The Turkish banks’ asset quality, as well as their CAR, kept deteriorating throughout the crisis. To
curb demand from businesses and consumers, banks continuously raised interest rates for business
and consumer loans and mortgage loan rates, towards 20% annually. Along with a corresponding
growth in deposits, the gap between total deposits and total loans, which had been one of the
highest in emerging markets, began to narrow.
This development, however, had also led to unfinished or unoccupied housing and commercial
real estate mushrooming the outskirts of Turkey’s major cities, as the president’s policies had
fueled the construction sector, where many of his business allies were very active, to lead past
economic growth.
In March 2018, home sales fell 14% and mortgage sales declined 35% compared to a year earlier
leading to Turkey currently has around 2 million unsold houses making up a backlog 3X the entire
chunk of the average annual new housing sales. By the first half of 2018, the unsold stock of new
housing kept increasing, while increases in new home prices in Turkey were lagging consumer
price inflation by more than 10 %age points.
Even though the CAD started narrowing in June, due to the worsening exchange rate for the lira,
heavy portfolio capital outflows persisted and hence as a consequence of the earlier monetary

policy of easy money, any newfound fragile short-term macroeconomic stability is based on higher
interest rates created a recessionary effect for the Turkish economy.
While Turkey’s refusal to free an American Pastor suspected in the Turkish coup attempt
aggravated the US which increased the burden on Turkey by way of doubling import duties on
steel and aluminum exports from the country. Even though, Turkey retaliated by increasing import
taxes on US goods, such as automobiles by 120 %, alcohol by 140 % and tariffs on coal, cosmetics,
and rice, the dominos started falling.
Now, the global economy faces three key risks namely, high debt, increasing financial
vulnerabilities, and protectionism. The fraught geopolitical situation is not helping either as the
more the contagion spreads from Turkey to other susceptible economies, the more the investors
will take profits on their good assets to balance for their losses elsewhere ensuring that decoupling
is impossible in the current state of financial markets.

Decoding the impact of Crisis in an Indian context

A possible rate hike in the US has invoked a sense of fear and left the investor community in a
state of nervous anticipation with the Turkish crisis further compounding a foreign capital flight
from all emerging markets. As an emerging economy, India is expected to face some turbulence
in the short term, as the flight of foreign capital affects the rupee on similar grounds.
As such, the rupee was among the hardest hit in Asia from the Turkey-led selloff in emerging
assets, largely due to a wide CAD, that is already strained by higher oil prices and this fall in the
rupee’s value has implications for India’s external debt and, there are costs to be incurred in
servicing in these debts since most of the debt was known to be on a short-term basis.
Although, the Indian economy has learnt from 2013 and is far stronger than when it was a member
of the Fragile Five (“Fragile Five” economies of 2013—Brazil, Indonesia, India, and South
Africa) — with our CAD being much lower and our FER much higher than what they were in
2013 and unlike Turkey, our external debt is low.
The MSCI India equity index was down a meager 1.9% indicating that the investors have
recognized India’s strengths in comparison, the MSCI Emerging Markets index was down by 8.3%
while among the former Fragile Five, MSCI Brazil was down 14.3%, South Africa down 18.6%,
Indonesia down 15.5%, while MSCI Turkey had plunged by 52.3%.
Factors such as the broader trend of currency movements in key emerging markets, the trend in
crude oil prices, and the trajectory of the greenback (USD) strengthening against other currencies
will be the ones that drive the outlook for the rupee in the short term.
A similar selloff at the time the crisis in Greece in 2009 was seen mainly on account of contagion
fears across the Euro currency union, but most don’t view the Turkey situation surging into a
crisis of those proportions. The US dollar is expected to strengthen further in the months ahead
with the anticipated rate hikes by the US Federal Reserve.
The RBI has been assessing the mercurial trend in the rupee vis-à-vis the emerging market
currency pack and will take necessary steps to weaken the rupee to protect India’s export
competitiveness if all emerging market currencies are depreciating as per the investment
information and credit rating agency ICRA. This is one of the primary reasons that there has been

very little RBI intervention till now as it is of the opinion that there are external factors which
are affecting the rupee.

Overall Macroeconomic Analysis

 Because of falling lira, the inflation is going to rise in the economy since the Turkish
economy is dependent upon foreign currency loans. This is evident from the fact that
inflation in the economy has already reached 15.6%.
 This will indirectly impact the entire economy as a whole. Ideally, whenever there is a rise
in the inflation, the simple monetary policy followed by the Central banks is to increase
the interest rates and by increasing the cost of borrowing reduce the money supply and
consequently the demand in the economy. Thus inflation levels are controlled.
 However, Erdogan (President of Turkey) believes in conservative principles stating that
“interest rates are the mother and father of all evil” and since there Central Bank is not
independent the rates are not hiked. This has also to do with the political reasons because
the President wants people to be happy with more money in their hands.

Recent US sanctions and tariffs imposed on steel and aluminum exports on account of
detaining American Pastor and tight fiscal policies have had a huge impact on the growth
of the economy and hence the country might soon face recession soon in the last quarter of
the year 2018.

Trade Wars
Turkey is the 9th largest exporter of steel with 12% of its exports going to the US. The
trade wars have been ongoing since the Syrian crisis but were exasperated with the arrest
of American pastor Andrew Brunson and hence America imposed tariffs @20% on
Aluminum and @50% on Steel exports from Turkey. Turkey also retaliated by imposing
tariffs on other American products. This will have a huge impact on turkey widening its

With President being totally against the rise in Interest rates, the best option available is to
seek assistance from IMF to provide assistance and by this way increasing the money
supply in the economy and foster growth by stabilizing Lira.

Current Account Deficit

Robust demand for goods and services had led to an increase in current account deficit to
USD 5.43 billion in April and the same has reduced to USD 1.8 billion in July because of
weaker Lira and softer domestic demand. Overall the current account deficit is still
estimated to be around USD 51.6 billion in the year which is one of the largest current
account deficits in the world.

Forex reserves
Countries forex reserves stand at USD 85 Billion which is comparatively lower than USD
181 billion in short-term debt denominated currencies other than the lira. Hence reserves
might not be sufficient to prevent lira from spiraling downward when it falls.

Turkey failed to attract FDI because of negative sentiments across the world which are safe
means of financing CAD and had to depend upon short-term debt from foreign countries
making the economy as a whole vulnerable.

Capital Flight
 Fearing the slump in lira, both the foreign as well as local investors are moving their money
out of the country. This leads to the problem of capital flight.
 In order to ensure that the currency does not depreciate further, the government must
implement capital controls wherein it disallows full-fledged capital flight.

Twin Deficit Problem

Similar to the USA, the country is facing twin deficit problem on account of huge
borrowings and high government expenditure which makes it CAD unsustainable.

Quantitative Easing
Adverse effects of QE have already been felt by a lot of emerging countries and Turkey is
no different leading to dramatic depreciation in currency and negative impact on the

Stock Market & Borrowing Cost

There has been a huge fall in the stock market by 17% and the government borrowing has
also risen by 18% due to fall in lira.

Emerging Countries
Emerging countries including turkey are facing acute problems since the central banks have
stopped Quantitative Easing techniques and instead increased Fed rates which have
resulted in capital outflows and hence fluctuations in their currency.

Possible Solutions to stem the Crisis
In order to clamp down this crisis, one of the steps that are being demanded by the international
markets is the hike of the interest rates (already above 17%) by the Turkish central bank, but
according to the school of thought that President Erdogan and his economic team represent, this is
something impossible for Turkey as it will be seen as a pressure by the foreign powers and
international market on Turkey. In any case, Turkey would have to raise its interest rate by
almost 750 points to bring the crisis under control to an extent.
The other medium to eke out of this precarious situation is the announcement of an emergency
package of financial support from the International Monetary Fund but a combination of both
these solutions together will be the most effective way out.