By guest contributor Sanjay Guglani, CIO, Silverdale Fund Management
While it is not known why release of a pastor became a key point for the president of the United States, what is indeed known is that an estimated 80% of evangelist Americans had voted for Trump in the 2016 presidential election. Interestingly, the US has refused to deport Fethullah Gulen, a Turkish cleric living in Pennsylvania, who is accused of plotting the 2016 attempted coup against Erdogan. On August 10, 2018, Trump decided Turkey’s export of steel and aluminium to the USA to be a national security threat and he announced a doubling of tariffs thereon via Twitter. In the context of a strengthening US dollar and rising oil prices (Turkey is a net importer of oil), the tariff increases led to a massive depreciation of the Turkish lira, dragging with it other emerging economies’ currencies.
Why Turkey’s currency crisis could be fatal
The key risk is that the currency crisis could become a debt crisis. At an exchange rate of 1 US dollar to 6 Turkish lira, a USD 100 debt is equal to TRY 600. However, if the Turkish lira depreciates, such that 1 USD is equal to 11 Turkish Liras, the same debt balloons to TRY 1,100. Such a depreciation leads to a larger effective debt as well as making debt servicing more onerous. This could become a vicious circle of spiralling debt, massive failures, bankruptcies and contagion.
How is high inflation tamed?
The basic tenets of economics demand that in case of rapid inflation (especially when the economy is growing at a supra-optimal rate of 7.4% (Q1, 2018) with a high current account deficit (at 6.5% of GDP), the central bank of the country should raise interest rates. By increasing interest rates, affordability of loans drops, hence there is less money in the economy. Since there is less money to fuel demand for goods and services, prices fall. That is, inflation falls.