Why is Turkish Lira Falling?
Time and again, Turkey faces a currency crisis. The Turkish lira has lost more than 40 percent of its value against the United States dollar this year, making it one of the worst-performing of all emerging market currencies.
Why is this happening?
Turkey’s central bank cut interest rates by 100bps in November – the third cut since September – triggering a sharp fall as it signalled it would slash rates again in December.
Well, you may ask, why does a rate lead to currency losing its value?
The answer is inflation. When a central bank lowers interest rates, money generally becomes less expensive to borrow and therefore less valuable relative to other currencies causing investors to dump the currency. Low rates encourage consumers to borrow more to buy things, and businesses to borrow more to expand operations and create jobs which lead to a sharp rise in prices of goods and services. Well, one must say this helps in economic growth, however, there has to be a right balance between inflation and economic growth and the central bank is responsible to maintain that balance.
Here’s what the Turkish President, Mr . Erdogan has to say — First, keep interest rates low. This allows businesses to borrow at more affordable rates and it gives them the room to grow and expand.
Well, the Turkish President is right but healthy economic growth suggests living standards should improve for Turks, unfortunately, that’s not happening because of soaring inflation. Turkish businesses that depend on imported goods are facing higher costs because the lira is weaker than ever before. And as the higher input costs are passed on to the consumers, Turkish households are facing higher prices for goods – including essentials. More so, Turks also see their savings and incomes erode as the Lira weakens.
Who's fault is this? After all, it’s the central bank that cuts rates, correct?
Central banks do set interest rate policy. But Erdogan has sacked three central bank chiefs over the past two years. The last governor to be shown the door was Naci Agbal, who lost his job in March after only four months in the role. But during his short time at the helm, Agbal oversaw a series of interest rate hikes that helped shore up the lira.
However Mr. President believes the best way to tackle inflation is to keep interest rates low. He believes that economic growth precipitated by the low interest rates will help the country produce more goods and services. And this in turn will help tame inflation and this hypothesis may put everything at risk.
So far, there are no signs of reversing his “unconventional” thinking on interest rates, or any greater tolerance of central bankers who disagree with his views. Only time will tell whether we would see a turnaround in Lira or Turkey would face an economic collapse.
Until next time.…