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Why Turkey’s currency is plunging and what it means

August 10, 2018

FILE - In this Wednesday, May 23, 2018 file photo, currency exchange vendors wait for customers in a market in Istanbul. The Turkish lira hit a record low of 6.24 per dollar on Friday, Aug. 10, 2018, before recovering to 5.94, down 7 percent on the day. The currency has fallen 66 percent since the start of the year. Turkey's President Recep Tayyip Erdogan on Thursday, Aug. 9 portrayed the currency drop as a "campaign" to harm Turkey. (AP Photo/Lefteris Pitarakis, File)

ISTANBUL (AP) — The tumble in Turkey’s currency on Friday signaled deepening pessimism about the country’s economy after months of market declines.

The lira fell as low as 6.75 to the dollar, down a whopping 14 percent on the day and 41 percent since the start of the year as investors worry about the country’s economic policies and a dispute with the United States that has led to sanctions and new tariffs.

Here is a look at the situation — what caused the plunge and what impact it might have.

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Q: Why is Turkey’s currency so weak?

A: Turkey’s economy has grown strongly in recent years, but that has required a lot of foreign investment and the country imports more than it exports. Together, that can weigh on the currency.

As the currency weakens, it can make foreign investors pull their money out of Turkish stocks and bonds as their lira investments lose value. To do that, they have to sell lira — worsening the rout.

The lira’s fall has been made worse by President Recep Tayyip Erdogan’s statements on economic policy. He has urged the central bank to not raise interest rates. Rate increases are the central bank’s main tool to support the currency and fight inflation. The central bank, officially independent, appears to have heeded Erdogan and has not raised rates when many — including the International Monetary Fund — said it should have. That drained investor confidence in the central bank, leading to a further sell-off of the currency.

Erdogan’s decision to name his son-in-law as finance minister also made people wonder about the direction of the country’s economic policy.

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Q: What about the dispute with the U.S.?

A: Turkey’s decision to jail a Protestant pastor from the U.S. has led to the U.S. imposing sanctions on two Turkish government ministers. Conservative evangelical Protestants are a key constituency at home for U.S. President Donald Trump.

The mere fact that the U.S. would impose sanctions on Turkey — a stalwart NATO ally for decades during the Cold War — has increased uncertainty about the future in Turkey.

Trump raised the stakes on Friday when he said that his administration would double its tariffs on Turkish steel and aluminum. That caused a further drop in the lira. The U.S. was Turkey’s biggest export market for steel last year, though exports have fallen since.

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Q: How is the fall in the lira a problem?

A: It is a problem for Turkish businesses and banks that get revenues in lira and owe money in dollars or euros. The lira has fallen about 40 percent against the dollar this year. That makes a loan in dollars that much more expensive to repay. So the sudden fall raises the possibility of corporate bankruptcies or bank failures that could hurt the economy.

The currency drop will also increase the cost of living for people in Turkey by making imports more expensive. Prices are already up 16 percent since last year and this week’s drop will make that worse.

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Q: What impact could the turmoil have outside Turkey?

A: There are some concerns about whether European banks would suffer losses on loans in Turkey. The euro currency dropped to a 13-month low on Friday, and bank shares fell.

Europe is also dependent on Turkey to restrain the flow of migrants from conflict in the Middle East in return for aid. Some 4 million displaced people, most them from Syria, are currently living in Turkey. Any resumption of serious migrant flows from Turkey would be a big political issue in Europe, where opposition to immigration has fueled the rise of right-wing parties such as Itay’s League and the Alternative for Germany.

But Carsten Hesse, analyst at Berenberg bank in London, says that an economic downturn in Turkey would have limited impact on Europe or other major economies. A 20 percent fall in exports would only reduce GDP by 0.1 percentage point or less per year in the 19 countries that use the euro currency. Hesse said that European banks could suffer losses if they loaned money in Turkey or owned Turkish banks but that the possible losses were not large enough to trigger a eurozone banking crisis.

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Q: What is Erdogan proposing to do?

A: Erdogan gave a speech Friday that mainly blamed foreigners for trying to destabilize the country. He equated the financial turmoil to the 2016 coup attempt that sought to depose him.

He told supporters to “change the euros, the dollars and the gold that you are keeping beneath your pillows into lira at our banks. This is a domestic and national struggle.”

His finance minister later promised that the central bank would remain independent and that inflation would come down. With little by way of detail, the promises failed to soothe markets.

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McHugh reported from Frankfurt, Germany.

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