📉 Turkey's Crazy Currency Crash
Turkey's currency has currently been in free fall. Here's why.
Imagine if prices of essentials fluctuated every single day. The bread that cost Rs. 12 yesterday suddenly costs Rs. 14 today?
This is what is happening in Turkey right now. The country's currency, the lira, is currently in a free fall and its value has declined by around 40% this year.
What's going on?Â
Interest Issues
Turkey's central bank has cut interest rates three times this year since September, and may further reduce the interest rate in December.Â
It's like the most common solution in the handbook of "How to deal with a crisis?" Several countries including India, and even the United States have lowered interest rates to tide up with the pandemic shocker.
You see, when the borrowing costs are low, people borrow more money. And because they have extra cash they spend more and boost the economy.Â
However, more is not always better. The economy is a fragile thing, almost like a house plant. It will die if you give it too little water and it will also die if you give it too much. For it to grow, everything needs to be perfectly balanced.Â
So, if interest rates are too low for a long period, things start to get problematic. When there's too much supply of money in an economy chasing the same amount of goods, it leads to inflation (Here's our in-depth explanation about the topic). And that's what happened in Turkey, where inflation was already very high. The decreasing interest rate has pushed the inflation rates even further.
But, what do inflation and low-interest rates have to do with the value of the currency?
Firstly, low-interest rates mean foreign investment in the country decreases. After all, why would you invest in a country that is giving you low returns? So, less foreign currency is coming into the country. The low supply means the foreign currency is getting more expensive and this drives down the value of the lira.
Secondly, because inflation and the declining exchange rates are eroding the value of lira, many Turkish citizens are converting their money into US dollars or gold. This has further increased the demand for the dollar.
So, the value of the lira as compared to the dollar has declined. (Higher demand+Limited supply= Price increase).
What this has resulted in is a highly unstable economic environment in the country. Many Turkish citizens cannot even bear the cost of their meals anymore.
The problem is further made worse by the fact that Turkey is heavily dependent on imports as well as foreign financing.
So, businesses that had borrowed from other countries have seen their debts increase because of no fault of their own.Â
Farmers, manufacturers, and other producers, who have to import essential items like fertilizers and textiles, have also seen costs grow because of the declining value of the lira. Many of these producers have chosen to hold their products in storage and are waiting for the lira to stabilize before they sell them. This shortage of items is just adding to the problems of the already troubled Turks. They are now resorting to violent protests.
So, is the central bank and the government doing anything about this?
The Central Bank's Dilemma
Turkey's central bank has attempted to solve the problem by selling off some of its foreign reserves. How is that going to help?Â
We just mentioned that high demand for US dollars was causing the lira's price to fall. So, the central bank hoped that increasing the supply of US dollars in the market would restore the lira's price. If demand matches supply then the price will no longer be high. Did this plan work?
Briefly. But the lira soon went into freefall again. So, what can the central bank do now?Â
It can do what many other countries have already done or are thinking of doing: increase interest rates. Now people will borrow less and slow down their expansion plans. What this will essentially do is reduce the excess supply of money in the economy, which will decrease inflationary pressure. This is yet another central bank go-to move.
What's stopping Turkey's central bank then?
The country's President.
Turkey's President Erdogan has one firm belief that increasing interest rates is an evil act that makes "the rich richer and the poor poorer". And while his logic somewhat makes sense, economists disagree with the idea. Because low interest rates ultimately increase the cost of things and the poor continue to get poorer.Â
Erdogan believes that inflation will go down and his economic policy will make the country's future bright. Anyone who disagrees with him has been shown the door. No, seriously. The man has fired three central bank chiefs in the last two years.Â
Surprisingly, this bizarre economic policy has had a silver lining. Supported with a strong rise in exports, Turkey's economy actually grew 7.4% in the third quarter as compared to a year ago. So, is Erdogan's policy sound then?
Umm, not really. Analysts have predicted the economy will contract sharply due to the decline in the lira's value.
So, opposition parties have called for snap elections in the country, hoping to replace Erdogan and with him his economic policy. But the country's future is still uncertain.
Whatever be the case, Turkey's situation has provided some food for thought to other countries. It has highlighted exactly how dangerous low interest rates can be in the long term.Â
When do you think interest rates will rise the world over?Â
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Low interest rate is helping industries and commerce... So they should focus to export more and earn foreign revenue to come out from trap if their population age support this....