From my previous professional life as a bank chief economist I remember very well the Turkish banking crisis of 2000/2001, followed by a major economic downturn (GDP 2001: -5.3%). Prior to the banking crisis, macroeconomic imbalances in mainly the budget and the current account had worsened alarmingly and, thus, strongly contributed to fading international confidence in Turkey’s financial – and also political – system. The lira weakened strongly at the time. Foreign investors sold huge amounts of their Turkish T-bills and even stocks. Logically, the currency reserves shrank dramatically. At the end of the day, the IMF provided Turkey with a 10.5 billion financial rescue package. After this, a serious political crisis followed all the same – before an economic recovery could be noted and the weak banking system was reformed into a more stable shape.
Unfortunately, the acute starting position of the current Turkish crisis does not look very different from the one 17 years ago. Major macroeconomic fiscal and trade imbalances exist also today. The Turkish currency has dropped substantially not only in recent days but also by around 35 percent so far in 2018.
Political conditions, however, look partly different this time – with other kinds of political leadership in both Turkey and the U.S., giving the current economic problems in Turkey even stronger political dimensions than in the beginning of this century. But this does not necessarily mean that the current Turkish crisis “automatically” will end in a more benign way, particularly when considering president Trump’s current resistance to potentially needed major international global financial rescue actions.
Worst case scenario
Still, the worst case scenario is only a scenario. But the current situation is critical and can aggravate further. The worst case scenario could include major bank problems in Turkey with contagion to EU banks that have major loan and securities involvement in the Turkish financial system. Such a development could lead to major GDP losses in mainly Turkey but also to a more limited extent in the EU. Read, by the way, more about this relationship in the research of Hyman Minsky!
All this leads to the conclusion that the coming development in Turkey should be given very strong analytical attention. President Trump’s future ideas and action play certainly an important role in this respect. Sometimes, he changes his mind unexpectedly in another direction. But Turkey itself should also under all circumstances work more ambitiously with its ongoing macroeconomic imbalances, particularly since the country is highly indebted abroad – both what concerns private and public debt.
Experience from other countries with similar challenges shows that nervous or speculating financial markets usually are stronger than the defense lines set up by the pressured country with its currency reserves – unless the acute problems are combatted promptly or surprisingly positive news make the whole picture brighter.
Affiliate Professor at the School of Business and Economics, Linnaeus University