The Fastest Growing Economy in the G20 and the Continued Depreciation of the Turkish Lira: Causes, Effects and Solutions

The Fastest Growing Economy in the G20 and the Continued Depreciation of the Turkish Lira: Causes, Effects and Solutions

One of the modern and contemporary ways to measure the performance of an economy of a country is to look at the value of its local currency against the dollar. Globalization spread all across the world and the competition of currencies have been witnessed.  So exchange rates are crucial when talking about the overall health of the economy of a specific country.

Before we explain the issue of the depreciation of the Turkish Lira in detail, we must know that there are three major types of exchange rate policies implemented by different countries all across the globe. These types of exchange rate regimes are: 1- Freely floating exchange rate regime, 2- managed floating exchange rate regime and 3- fixed exchange rate regime.

The first one, freely flouting exchange regime, is determined by the market, meaning that the interactions of the demand and supply of the currency in the local market make an equilibrium. That equilibrium determines and gives us the exact price or value of that certain local currency against the hard currencies as shown in figure 1. The curve (S) represents the supply of the currency where by (D) represents its demand. Point (E) is the equilibrium and gives us the price of the currency which is 10.

Graph (1)

The second one is the most widely used regime which is not to fix the exchange rates but still is to manage the exchange rate to minimize its negative effects such as the inflation due to the devaluation of the local currency against the dollar and the deficit in the balance of the payments between that specific country and the rest of the world.

The last one is the fixed exchange rate regime which is implemented by a few countries. China is an example of those countries. In this regime, exchange rates are fixed by the central bank of the country.  As shown in graph (2), for example 1 Euro is equivalent to $4 and it is fixed. It does not matter whether the supply or the demand of the Euro is increased or decreased. 

Graph (2)

All these three types of exchange rate regimes have their own advantages and disadvantages but now we don’t need to explain them deeply. In this case, the depreciation of the Turkish Lira, managed exchange rate regime is going to be discussed in particular as Turkey is one of those countries which implement this type of exchange rate policy.

The overall amount of the hard currencies entering into the country or going out of the country is the major determinant of the value of the local currencies against hard currencies in the local markets. In other words, the demand and supply forces in the market decides the price of every currency unless it is fixed or managed by the central bank. 

Since the end of February, Turkish Lira tumbled an average of near to 4% against the dollar. One dollar buys 3.94 Turkish Lira on 29.03.2018. Still, some economic experts predict that the depreciation will continue in the upcoming three months. 

Exports and imports have huge influence on the fluctuations in the exchange rates of a country. So, if the exports are high it means that there is hard currency coming in to the country which makes its supply in the country huge. In that way the local currency gets more value over the hard currency. As shown in the graph below, when the quantity of dollar increases from Q1 to Q2, the supply curve shifts to the right it means there is an increase in the supply of dollar from S1 to S2 and thus there must be a reduction in the price, the value, of the dollar from P1 to P2.

Graph 3

The opposite will happen if the imports are match larger than exports in which the hard currency is draining out of the country. So, the supply and the availability of the hard currency becomes trouble and that causes the value of the local currency against those hard currencies to become very low. So the country’s balance of payments tend to decrease dramatically. Then, the government will be forced to borrow money to finance the deficits and even that may result farther more dangers of the increased interest rates on the borrowed money which may make the situation even worse for the country’s economy.

As shown in the graph below, when the quantity of dollar decreases from Q2 to Q1, the supply curve shifts to the left it means there is a decrease in the supply of dollar from S2 to S1 and thus there must be an appreciation in the price, the value, of the dollar from P2 to P1.

Graph 4

In recent years, Turkish exports have fallen because several factors including the low attention of the Turkish exporters to export more due to the foreign competition. Also the importation of the raw materials by the Turkish exporters to make their finished goods to be exported have also their negative consequences as they contribute to the deficits in the balance of payments of the country. 

Some other ideas suggest that the rapid growth of Turkish economy is the major cause of the Turkish lira to be devaluated against the dollar or against all other hard currencies coming in to the country. Turkey is the fastest growing economy in the G20. Turkey’s economy has recovered from a downturn that followed a failed coup last year, helped by a series of government stimulus measures. Gross domestic product grew 11.1 percent year-on-year in the third quarter, its fastest expansion in six years, data showed on Monday. Records show that in the last year 2017 the economy of Turkey grew at a rate of about 7.4% which still makes Turkey the fastest growing economy in the G20 (Reports by Ezgi Erkoyun, Can Sezer, Ebru Tuncay; writing by Daren Butler; edited by Larry King)

The rapid growth of the economy of the country is the result of increased employment. The Turkish unemployment rate fell to 10.4 percent in December 2017 from 12.7 percent in the same month of the previous year. The number of unemployed decreased by 581 thousand from the previous year to 3.291 million while the number of employed went up by 1.619 million to 28.288 million.

The increase in the employment rate resulted from the increase in the economic growth rate of the country and that causes an increase of the incomes of the Turkish citizens as more people get jobs. That in turn increases the overall demand of the Turkish people which ultimately increases the consumption of the Turkish people.

This kind of economic boom and increase in the incomes of the Turkish people causes the circulation and the supply the Turkish Lira in the local markets to increase and that is why it loses its value against the dollar in the market as shown in graph 5.

Graph 5

(As the quantity of Lira increases from Q1 and moves to Q2, its supply increases from S1 to S2 and thus its value drops from P1 to P2)

Another idea says that the recent continued depreciation of Turkish Lira is a result of political actions made by the FETO to weaken the Turkish economy. The FETO is the group tried the failed coup attempt on 15 July 2016. The group was made up of senior politicians and merchants who used to have power and too much money in the country.

Apart from the failed coup attempt, what the group did was that of withdrawing huge amount of money out of the country in dollar cash. That made the country suffer from running out of dollar cash.

Graph 6

(As more dollars are withdrawn and go out of the country, it means that the quantity of dollar in the country decreases from Q1 to Q2 reducing its supply from S1 to S2 and thus appreciating its value from P1 to P2).

Other Turkish economists explain the matter by emphasizing and remarking that the lower interest rate by the Turkish Central Bank (TCB), which is highly supported by Turkish government authorities, is the main cause of the continued and ongoing depreciation of the Turkish Lira.

Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise.

However, Turkish authorities argue that a rise in the interest rate is not good for Turkish economy and to do so, will hinder the growth of the Turkish economy and also to finance the construction industry which is the back bone of the Turkish economy. 

Political instability is one of the major subjects that some economists believe it is the biggest cause of the Turkish Lira depreciation. Some people believe that the current Turkish military operations in Syria contributes the Lira to depreciate farther.  

Since the failed coup attempt, Turkey experienced some political tensions and terror attacks which made foreign investors afraid of coming and investing in the country. Even some of the previous foreign investors withdrew their money out of the country and these made the country to run out of hard currency.

All those issues discussed above are what economists think that they are the causes of the dramatic and continuing depreciation that the Turkish Lira is experiencing nowadays.

To mitigate the devaluations of Turkish Lira in the short run, the solutions which are suggested by the different economists, including me, seemed to be concluded into one option for the Turkish Central Bank (TCB) to do. It is the interest rates to be increased at a rate of about to 12%. Otherwise the Turkish Lira will continue its depreciation against the dollar.

That is the instant solution because an increase in the interest rates can fix the problem immediately. Still there are other solutions to deal with problem like promoting and increasing the exports but its effect may not be seen very soon. Turkish exporters may see the devaluations in the Turkish Lira is an opportunity for the them and as a chance of becoming competitive in the international markets. So that they may increase their exportation.

Increase in the interest rate is a quick remedy for dealing such issues as it decreases the amount of Turkish Lira circulating in the market. In turn it will gain its lost value against hard currencies in the market again.

Interest rates also attract the attention of the foreign investors as they see it as an opportunity and they promptly start investing in Turkey and bringing hard currency into the country which increases its supply in the local markets and thus reducing its value against the local currency.  

In conclusion, there are five major different ideas regarding the causes of the recent continued depreciation of the Turkish Lira against hard currencies. These five major issues are: 1- The increased growth causes the devaluation of the Turkish Lira, 2- deficit in the balance of payments of the country with the rest of the world, meaning more imports than exports, 3- 15, July coup followed by an economic coup, 4- the lower interest rates by the central bank the country (TCB) and 5- the recent political instability in the country.

Increase in the interest rate is the only quick remedy for dealing such issues as it decreases the amount of Turkish Lira circulating in the market and also attracts the attention of the foreign investors to invest in Turkey and bring hard currency into the country.

Abdiqadar Abdigani Mohamed 

Economic Growth and Development 

Gazi University