Mohamed A. El-Erian
Rather than sticking with the approach taken by numerous other countries – including Argentina earlier this year – by raising interest rates and seeking some form of IMF support, Turkey has shunned both in a very public manner. Unless it changes course, the government risks much wider damage – and not just in Turkey.
Whether by accident or design, Turkey is trying to rewrite the chapter on crisis management in the emerging-market playbook. Rather than opting for interest-rate hikes and an external funding anchor to support domestic policy adjustments, the government has adopted a mix of less direct and more partial measures – and this at a time when Turkey is in the midst of an escalating tariff tit-for-tat with the United States, as well as operating in a more fluid global economy. How all this plays out is important not only for Turkey, but also for other emerging economies that already have had to cope with waves of financial contagion.
The initial phases of Turkey’s crisis were a replay of past emerging-market currency crises. A mix of domestic and external events – an over-stretched credit-led growth strategy; concerns about the central bank’s policy autonomy and effectiveness; and a less hospitable global liquidity environment, owing in part to rising US interest rates – destabilized the foreign-exchange market.
A political spat with the US accelerated the run on the Turkish lira by fueling a self-reinforcing dynamic. And all of this occurred in the context of a more uncertain and – aside from the US – weakening global economy.
In keeping with the traditional emerging-market-crisis script, Turkey’s currency crisis spilled over onto other emerging economies. As is typically the case, the first wave of contagion was technical in nature, driven mainly by generalized outflows from Turkey’s currency and bond markets. The longer this contagion continues, the greater the concern that it will lead to more disruptive financial and economic outcomes. As such, central banks in several emerging economies – as diverse as Argentina, Hong Kong, and Indonesia – felt compelled to take counter-measures.
What has followed is what makes this episode of emerging-market crisis different, at least so far. Rather than sticking with the approach taken by numerous other countries – including Argentina earlier this year – by raising interest rates and seeking some form of support from the International Monetary Fund, Turkey has shunned both in a very public manner, including through strident remarks by President Recep Tayyip Erdoğan.
Facing an accelerated exchange-rate depreciation that, at one stage, almost halved the lira’s value, Turkey has taken a variety of measures that attempt to simulate – albeit partially – the traditional approach that emerging economies have tended to follow in the past.
Domestically, it tightened funding conditions and, at the same time, provided liquidity to domestic banks, along with regulatory forbearance. It made it harder for foreigners to access lira liquidity, thereby squeezing speculators that had shorted the currency. It promised to deal with credit and fiscal excesses while ruling out capital controls. Externally, the government has mobilized at least $15 billion from Qatar to be used for direct investment in Turkey. And, in the midst of all this, the government also found time to retaliate against the doubling of tariffs on Turkish metal exports by US President Donald Trump’s administration.
The question is whether this response will be enough to act as a circuit breaker, thus giving the Turkish economy and its financial system time to regain their footing. This is particularly important because continued currency turmoil would tip the economy into recession, raise inflation, stress the banking system, and increase corporate bankruptcies.
With this comes the toughest question of all for the government: Can it bring about recovery without reneging on its pledge not to raise interest rates or approach the IMF? It is possible, but not probable.
Absent additional measures, it is unlikely that a critical mass of corrective steps has been attained in Turkey. While the domestic policy adjustments provide short-term relief for the currency, they may be neither comprehensive nor sufficient as yet to return Turkey to a promising path for inclusive economic growth and durable financial stability.
On the external side, the funding from Qatar, assuming it materializes fully and in a timely fashion, appears small relative to Turkey’s gross external funding needs. It also doesn’t come with the IMF imprimatur that reassures many investors. And it is far from clear how this money will make its way into the economy to maximize the potential for currency stabilization.
And then there is the trade skirmish with the US.
Like other countries, it is only a matter of time until Turkey comes to the same realization as others about confronting the more protectionist stance adopted by the US. Because of its size and systemic influence, and assuming it remains willing to incur the risk of suffering some damage in the process, the US is destined to win a tit-for-tat tariff escalation. As such, the best approach is what the European Union decided to do last month: seek a way to pause the skirmish while working on the longer-term underlying issues.
Rather than rewriting the game plan for crisis management in emerging markets, Turkey may well end up confirming it. One hopes this will lead to the restoration of financial stability and growth as the government looks to reverse its stance on central-bank independence, interest-rate policy, and perhaps even the IMF. The alternative – persisting with the current approach and, in the process, running the risk of turning technical dislocations into much more damaging longer-term economic and financial disruptions – would also prove problematic for other emerging economies.
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