Why the Collapse of the Turkish Lira Matters

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Why the Collapse of the Turkish Lira Matters

On Friday morning, the Turkish lira fell by more than 20% versus the US dollar, reaching new lows, continuing the currency’s years-long slide. The lira’s depreciation has increased sharply in 2018, but Friday’s one-day drop considerably beyond any prior slump.

The chart below shows a one-year daily chart of the US dollar vs the Turkish lira. Because the dollar is the initial, or base, currency in the USD/TRY currency pair, the chart’s fast climb reflects the lira’s significant fall versus the dollar.

Source: TradingView

Severe economic and geopolitical problems that have persisted in Turkey coupled on Friday to generate the unusually severe currency movements.

U.S.-Turkey Relations

Consistently worsening ties between the United States and Turkey have reached worrying proportions in recent years, causing a serious damage to both Turkey’s economy and currency.

Washington just issued fresh penalties against Turkish officials this week in reaction to the incarceration of an American pastor suspected of assisting a failed coup against Turkish President Recep Tayyip Erdogan in 2016.

Then, just as the Turkish currency was in rapid fall, U.S. President Donald Trump exacerbated Turkey’s troubles by putting drastically higher tariffs on Turkish metal imports.

Trump tweeted:

I have now approved a doubling of steel and aluminum tariffs on Turkey as their currency, the Turkish Lira, falls quickly against our extremely strong Dollar! Aluminum will now account for 20% of the total, while steel will account for 50%. At the moment, our ties with Turkey are strained! — Trump, Donald J. (@realDonaldTrump) August 10, 2018

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Despite President Erdogan’s efforts to contain the damage, the tweet increased pressure on the tumbling lira.

Rising Inflation, Low Interest Rates

Concerns over Turkey’s fast growing inflation – exceeding 15% year on year in July – have not been addressed by commensurate interest rate rises by the country’s central bank. President Erdogan has put pressure on the central bank to keep interest rates low by delaying much-needed raises. An artificially low interest rate environment has added to the Turkish lira’s persistent challenges.

Potential Turkish Debt Crisis

Turkey’s significant debt obligations to other nations are reflected in the very high proportion of its debt denominated in other currencies. As the lira continues to fall in value, Turkey’s foreign debt becomes more difficult and costly to handle, potentially exacerbating the currency’s downfall. A coming financial crisis that might result in a Turkish request for IMF assistance or a bailout could have substantial European and global economic ramifications. Turkey’s very big current account deficit increases the country’s vulnerability to a serious debt crisis. However, the worldwide danger posed by Turkey’s financial woes is rather minor. According to the Bank of International Settlements, global exposure to Turkish loans amounts to $265 billion, or less than 1% of total global exposure. Nonetheless, a Turkish financial crisis might have unanticipated ramifications across the already fragile region.

No Solution in Sight

On Friday, President Erdogan attempted to prevent currency losses by pushing Turkish people to fight the economic war against other nations by purchasing lira with other currencies and gold. However, this effort to inspire national enthusiasm in support of the Turkish currency was not immediately effective. Long into Friday afternoon, the lira remained under heavy pressure versus the US dollar.

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Aside from the impact a potential Turkish debt crisis may have on European markets and financial institutions, which could have repercussions on other global markets, the falling lira is important because it helps to depress an already-weak euro and strengthen the US dollar, which has been rising sharply for much of this year.

As President Erdogan maintains his iron hold on the Turkish government, economy, and people, and the threat of a Turkish debt crisis looms, the country’s economy and currency are likely to stay under severe strain.

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