Turkey crisis could reverberate across global economy, ex-IMF official says

A Turkish economic crisis may be looming and could send shudders through the global financial system, a former International Monetary Fund official said.

Turkish President Recep Tayyip Erdoğan is flouting the teachings of the world’s most renowned economists such as Nobel laureate Milton Friedman by insisting higher interest rates are inflationary and seeking to fix the value of the lira, said Desmond Lachman, a former deputy director in the International Monetary Fund's Policy Development and Review Department.

“A full-blown Turkish exchange rate crisis could have unwelcome ramifications for the rest of the world economy in general, and for French, Italian, and Spanish banks in particular,” Lachman, a resident fellow at the American Enterprise Institute, and John Kearns, a research assistant at the AEI, said in an article published in The Bulwark on Sunday.

Erdoğan sacked the governor of the central bank in July last year and since then monetary policymakers have slashed interest rates to 8.25 percent from 24 percent despite a revival in inflation, which stood at 12.6 percent in June. Meanwhile, the central bank has sought to defend the lira by spending tens of billions of dollars of its foreign currency reserves this year, meaning its net reserves, minus liabilities, are in negative territory.

Lachman and Kearns drew attention to Turkey’s external debts of $450 billion and its highly indebted corporate sector with more than $300 billion in borrowings. The companies would have difficulty servicing those foreign currency obligations should the lira plunge, putting even more pressure on an already shaky banking system, they said.

The lira fell to 7 per dollar last week, the lowest level since mid-May, when it hit an all-time low of 7.269 against the U.S. currency. The central bank had defended the lira at 7 per dollar in April and again at 6.85 per dollar for several weeks in June and July. It has partnered with state-run banks to bolster the lira through currency swaps and other methods.

Turkey's state-run banks are controlled by the country's sovereign wealth fund, which is chaired by Erdoğan.

The lira was little changed at 6.96 per dollar on Monday morning local time in Istanbul.

A wave of corporate defaults coupled with a Turkish banking crisis “could send shudders through the global financial system”, Lachman said.

“For the sake of the global economy, and especially for the sake of the poor Turks who have to bear the brunt of Erdoğan’s policies, we should all hope that he will prove Friedman and a host of other economists wrong,” Lachman said “Not that I’d bet on it.”

(Corrects typo in penultimate paragraph.)