The Turkish Lira Crisis of 2014
What is the Lira? According to The Editors of Encyclopaedia Britannica, The Lira was first introduced by Charlemagne in Europe. The currency later spread to Italy (Italian Lira – 1863). In 2002 Italy changed its legal tender over to the Euro. Malta also had adopted the Lira (Maltese Lira – 1983). Malta also changed their currency over to the Euro in 2008. Finally, the Ottoman Empire used the Lira. (Ottoman Lira – 1881). The Ottoman Lira was then replaced by the Turkish Lira in 1927. The Turkish Lira now depicts Kemal Atakürk, the founder and first president of modern Turkey. Today one Turkish Lira is worth ~ $.19 USD, according to XE.com. This is lower than in March of 2014, right around when crisis began. In 2014 one Turkish Lira was trading at ~ $.466 USD.
In the 1980’s, Turkey abandoned import industrialization and adopted export- oriented industrialization in an effort to integrate with the global economies. Due to this state During the 90’s the liberalization of capital movements and the Turkish Lira was made convertible. The public deficit grew in Turkey’s economy between 1991 and 1994 when the funding of public deficits from the Central Bank increased real growth, but also resulted in increased current balance deficits. Interest rates skyrocketed. To overcome these unfavorable conditions, a program was announced on April 5th, 1994, which did not work. The economy had an initial recovery period, but then the Asian crisis of 1997 struck Turkey's economy. In the face of the country’s enormous public deficits and high debt level in 1999, the policies they had in act were no longer sustainable. By the end of 1999, the country’s economy had shrunk by 6.1 percent, the inflation rate hit 70%, and the budget deficit grew enormously. The average annual compound rate for treasury interest reached 106% and the total outstanding debt amounting to 60% of GDP. Having suffered from two-digit inflation rates for nearly three decades, Turkey reached an unsustainable point (Eğilmez, 2003). During August of 1999, the country was shaken by a major earthquake. This did not help at all with the current economic situation occurring.
The new “Banking Law” was approved in June 1999 and a program to reduce inflation for the year 2000 was outlined in a letter of intent sent to the International Monetary Fund in December 1999. The second part of the program involved the changes in foreign exchange rate and monetary policies. While structural reforms and privatization programs made up the last step of the program. However, despite all these measures, the inflation target was not met and interest rates fluctuated. The Turkish lira was overvalued since the actual inflation rate was higher than expected, which decreased the competitive power in exporting by making purchase of imported goods more attractive (Eğilmez & Kumcu, 2002). The rapidly growing current account deficit could only be sustained through foreign capital inflow. However, due to insufficient foreign capital inflow, there was now a devaluation expectation in the country, as a result of which foreign fund managers cut down on their loans. Thus, about 4 billion 800 million dollars of portfolio investment fled out of the country and a liquidity problem arose in the market when banks increased their demand for foreign currency to close their open positions in expectation of a devaluation. In the face of an increasing demand for liquidity, the Central Bank did not provide liquidity to the market in order to meet objectives of the IMF program prescribing to keep foreign exchange reserves at a minimum level and to increase the monetary base so that it could keep up with the increase in net foreign assets. There was an effort to curb the increasing demand for foreign currency by raising interest rates. On 22 November, overnight interbank overnight interest rate rose up to 110.8%, reaching a maximum value of 210%. The Istanbul Stock Exchange (ISE) 100 index continued to move down and declined to 7329 on December 4 (Törüner, 2001). To clear the air of panic, the Central Bank was forced to pump money into the market in the end. Thus, the crisis of November 2000 was caused by low liquidity rates and troubles in the banking sector. The crisis of November 2000 could only be kept from deepening further by an additional IMF loan of $7.5 billion and the fact that the people did not convert their liras to foreign currency after all (İşler, 2004:40).
The overall economy did not change after the 2000 crisis. Overvaluation of TL, high inflation rates, and ever-growing outstanding domestic debt created doubts about the sustainability of the currency peg. Private banks sought to reinforce themselves before a possible devaluation by calling back the loans granted to public banks and buy foreign currency with the cash. Public banks were unable to meet such sudden high demand. They requested loans from the Central Bank to fulfil their obligations. Yet, the Central Bank had stopped lending money to the market to protect its reserves, but interest rates skyrocketed to unprecedented levels as the banks’ demand for TL did not stop (Gökçen 2001). A serious liquidity crisis arising in February 2001 rapidly depleted the foreign exchange reserves. As a result, the currency was allowed to float on the night of February 21. Interest rate and inflation rate increase and uncertainty grew as foreign currencies were allowed to float. The “Transition to a Stronger Economy” program was introduced in May 2001. The new stabilization program mainly aimed to solve the crisis of trust in the public, to stabilize markets, and to continue with the efforts to lay down the foundation for restructuring of the economy by public government. However, the program did not help the country come out of the uncertainty caused by crises since it failed to set forth clear macroeconomic goals.
The period between 2002 and 2006 witnessed a favorable financial environment. In this period, growth rates increased steadily and the country enjoyed low inflation rates and low real interest rates and benefited from increasing increased stock prices and returns. However, the 2008 crisis, which broke out in 2007 in the US as a mortgage loan crisis and later spread around the globe, did not leave Turkey’s economy intact. Growth rates declined and unemployment increased. The most significant impact of this global financial crisis on Turkish business sector was shrinking domestic and foreign demand, which brought about various problems. The increase in the number of the unemployed due to firms’ insolvency and layoffs and decreasing purchasing power and demand as a result of increasing unemployment rates were among the newer problems (Danacı & Uluyol, 2010). Still, as opposed to the 1999-2001 crisis, financial markets did not experience ups and downs. In 2009, the slowdown in global trading volume and particularly the dramatic deterioration in the growth performance of the EU countries, which are Turkey’s most important trade partners, as well as inadequate demand conditions led to a considerable shrinkage in the country’s foreign trade. Nonetheless, Turkey’s economy underwent a rapid recovery by achieving a growth rate of 6% during the last quarter of 2009. In fact, its growth rate increased by 11.7% within the first quarter of 2010 in comparison to the same period of the previous year, by 10.3% in the second quarter, and by 5.5% in the third quarter of the year. Turkey’s current account deficits showed a rapid increase trend in the wake of the global financial crisis and were financed by portfolio investments and other investments, which presents a risk for the country. In addition, the continued increasing trend of outstanding foreign debt in the post-crisis period and possible unfavorable conditions in foreign conjuncture may also add to the risk perceptions of foreign investors, which might become a significant problem that could interrupt economic growth (Taban, 2011:30).