What Should the EU Do About the Turkish Currency Crisis?

By Grégory Claeys, a research fellow at Bruegel as well as an Associate Professor at the Conservatoire National des Arts et Métiers and Guntram Wolff, the Director of Bruegel who formerly worked at European Commission,the Deutsche Bundesbank and acted as an adviser to the International Monetary Fund. Originally published at Bruegel

What is the problem?

The Turkish lira has lost more than 30% of its value against the US dollar since the beginning of this year. After the political escalation of tensions between the US and Turkey and the increase in tariffs on some Turkish imports last week, the lira was temporarily in free fall. The situation seems to have stabilised now, but there are still significant questions on the economic situation.

Turkey has, , about 23% of short-term external debt – i.e. about $180bn of external debt – mostly from non-financial corporates that needs funding. The IMF has warned of the overheating economy and called for more caution on the fiscal guarantees on banks’ loan programmes and other implicit liabilities. Nevertheless, Turkey’s public-debt-to-GDP ratio is limited to around 28% and the deficit is above 3%. The current account deficit is above 5%. So the overall numbers indeed suggest that a correction in macroeconomic policies is needed.

It is too early to say that Turkey will need a , as some have suggested. Certainly, if the political conflict with the US escalates, the nervousness in markets towards funding Turkey will increase. And while the lira has stabilised in the last few days, the whole situation certainly calls on European policy makers to reflect on what should be the EU’s position towards Turkey.

What are the reasons for the EU to care?

There are three main reasons for the EU to care about the current Turkish crisis. First, a financial crisis in a neighbour country of the EU could have a direct negative impact on the EU economy, mainly through the operating in Turkey (in particular from Spain, France, Italy and Germany) and through trade with Turkey.

Compared to the size of the European economy, these exposures to Turkey are relatively small and should be manageable. However, even though the European recovery started in 2013, some European countries are still vulnerable – as could be seen in the reactions of bond markets for and . To what degree Turkey’s economic problems will lead to a strong loss of confidence in other emerging markets is a moot point. The suggests some contagion – but there are also : direct contagion should not be very strong, but there are some global common causes that drive an increase in risk spreads for emerging markets, such as the normalisation of monetary policy and the strengthening of the dollar.  With Turkey’s GDP standing at roughly $900 billion, the economic ripple effects of a possible deepening of the crisis in Turkey should be manageable for the EU.

The second reason to worry about a crisis in Turkey is because of possible political knock-on effects and resulting changes in Turkey’s migration policy. Turkey is a transit country for most refugees, but also economic migrants, that want to come to Europe from the Middle East and Asia. The EU has a deal in place with Turkey on Syrian refugees. Could a financial crisis change politics so much that it would lead to a change in Turkey’s approach to migration? The answer to that question is of great importance to the European Union.

Finally, geopolitical considerations are also important. President Erdogan has already that his country could turn its back on the West and look for new allies. Turkey has been a NATO ally since 1952 and has for a long time played an important supporting role in the Middle East for western countries. Moreover, Turkey is still officially an EU accession country. Turkey might find it difficult to identify other allies that would be able to fund it in case the crisis deteriorates strongly. However, that view presupposes a rational approach to the situation. So the EU should be carefully considering the geopolitical threat, as it would obviously have strong implications for the EU.

What are the instruments the EU has at its disposal if Turkey was to request help?

The IMF is the obvious candidate to provide financial assistance to a country with a textbook balance-of-payments crisis, in clear need of dollar funding. However, even though the US does not have a veto right in the executive board of the IMF, de facto it might be difficult to put in place an IMF programme without the US agreeing to it. And such an agreement could prove difficult to reach these days, given the of the US administration towards Turkey and its recent decision to impose sanctions and to double tariffs on Turkish steel and aluminium.

If an IMF programme is difficult to reach (or if Turkey does not want to deal with the IMF) and EU countries think it is in their best interest to avoid an escalation of the crisis in Turkey, the EU could try to organise a financial support package on its own. In fact, the EU has some instruments to raise funds and provide financial assistance to countries experiencing financial difficulties.

In particular it could use its Macro-Financial Assistance (MFA) programme, reserved for non-EU partner countries. This has been used in recent years to help countries of the EU neighbourhood such as Tunisia, Jordan, Moldova, Georgia and Ukraine.

What makes it difficult to intervene for the EU? 

However, using an MFA programme for Turkey might prove difficult.  First, the EU explicitly that “a pre-condition for granting MFA is the respect of human rights and effective democratic mechanisms”, which might be difficult to justify for Turkey after the systematic crackdown on the Turkish press and political opponents of the last two years.

Second, the involvement of the IMF is also considered necessary as an “MFA is also conditional on the existence of a non-precautionary credit arrangement with the IMF and a satisfactory track-record of implementing IMF programme reforms”.

Third, the amounts of MFA loans are generally quite limited and far from what a Turkish bailout would require in the current crisis (the largest MFA involvement – to Ukraine – amounts in total to only ). In fact, to cover potential defaults on these loans, the EU has established a Guarantee Fund for External Actions that needs to represents 9% of the liabilities and that is constituted by gradual payments from the EU budget (see ) thus limiting considerably the lending capacity of the MFA.

In conclusion, what should the EU do?

The question of whether to provide support to Turkey first and foremost depends on the Turkish government actually wanting support. But deciding to support Turkey is a difficult political question for the EU.

First, it should be clear that EU countries are more vulnerable to a possible Turkish meltdown than the US due to their geographic proximity. The EU should therefore quickly develop a common position and be able to act with appropriate instruments. That suggests that the EU’s MFA instrument should be made independent of IMF decisions, which is not the case as it stands today.

Second, the EU needs to form a clear view on whether such an instrument should be a way to advance democratic values, or whether the EU should have a more functional approach – like the IMF – and limit conditionality on specific macro-structural policies.

Some European politicians such as Bundestag Green member Cem Özdemir already announced that “without a return to democracy and rule of law”. But asking for political change in the context of financial assistance could dramatically backlash in Turkish domestic politics. It could be used by Erdogan as an argument that the West and the EU are part of a conspiracy against him and Turkey. The EU thus needs to walk a careful line.

However, good governance is fundamental for the long-term well-being of Turkey and for the implementation of sound economic policies. One of the reasons for market nervousness towards Turkey is grounded in the fact that the Turkish president has appointed his son-in-law to be the finance minister, casting doubt on the quality of policies.

In the end, the EU’s best approach is to wait and see how Turkish domestic politics evolves. But, in the meantime, the EU cannot be an indifferent bystander. It needs to develop its own policy line and its proper instruments now.


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34 comments

  1. Ignacio

    Second, the EU needs to form a clear view on whether such an instrument should be a way to advance democratic values, or whether the EU should have a more functional approach – like the IMF – and limit conditionality on specific macro-structural policies.

    This is stupid. I wonder what kind of democratic values can you advance using financial chantage as an instrument. Wasn’t the objective to avoid crisis spreading and deepening? I am not saying the author of the article is stupid by stating this. Almost certainly this discussion will be held in the Comission. I just believe that the outcome will be stupid because the Comission won’t be able to distinguish between first, second or third order objectives and nothing will be achieved, as usual.

    1. Ignacio

      For similar reasons I think that what Trump is doing is stupid. What is the objective of this easily avoidable crisis? It is a first, second ot third order objective? I doubt Mr. President has a clear objective except for shaking the tree to see what happens.

      1. nervos belli

        Is it a crisis for the US? Anything meaningful Erdogan can do? How exposed are US banks? US has ~10 billion of exports to Turkey, but considering how the turkish economy is going for the last few years this is probably lost money anyways: Turkey is actually broke if looked at realistically.

        For Trump it’s probably simply to tell Erdogan who is boss. And considering the way Turkey behaved the last ~10 years, it’s high time for a telling.
        “Either you do as you are told, or it’s over”. If Erdogan has shown one thing the last few years, it’s that he only respects force not negotiation.

    2. oh

      The same paragaraph jumped out at me as I skimmed the article. Whenever these folks talk about :democratic values” it reminds me of how they destroyed a stable country like Libya.

      1. timbers

        I guess this is why the IMF wouldn’t lend to Ukraine: However, using an MFA programme for Turkey might prove difficult. First, the EU explicitly states that “a pre-condition for granting MFA is the respect of human rights and effective democratic mechanisms”, which might be difficult to justify for Turkey after the systematic crackdown on the Turkish press and political opponents of the last two years.

  2. AbateMagicThinking But Not Money

    Back in the 19th century the British tried to force political change on the Ottomans in exchange for support against the Russians. The general idea was to open up the Turkish market to British goods and block direct access to the Med for the Russians. From what I’ve read internal changes the Ottomans agreed to was only partially forthcoming. Unfortunately I can’t offhand remember the book I read about the Crimean War in which this policy was described.

    The British learned early on that cultural changes are the hardest to obtain – something others are still trying to do by force of arms and the installation of puppets.

    Having gone with the West for more than a century and a half, I suspect that the Turks are ready and willing to give the East a try instead especially as China seems to be in the ascendant and not sniffy about human rights.

    Pip-Pip

  3. Which is worse - bankers or terrorists

    Couldn’t Erdogan use the release of refugees back into Europe as leverage?

    1. Marlin

      In principle, yes, but
      – he would break an agreement with the EU, in which the EU side has kept its part; this could reduce trust in Turkey and its ability to honour treaties and would lead to a suspension of the money payments made by the EU in the context of this agreement.
      – while not keeping the agreement will hurt the EU, I see very little upside for Turkey; more refugees will try the Turkish route again if there is a realistic chance to reach Europe via this route.
      – the political effect in European countries could be very well to strengthen those parties, that are very critical of Turkey anyhow. In that case, a more robust response towards refugees from the EU side becomes more likely and the future of Turkish relations with the EU gets shakier.
      So using the refugees as a bargaining chip in this is very risky for Turkey. Erdogan still might try it, but it would be a very Trumpian approach, which usually can only work from a position of strength, which Turkey simply hasn’t.
      There are of course in the article lots of assumptions taken for granted in point 3:

      Finally, geopolitical considerations are also important. President Erdogan has already announced that his country could turn its back on the West and look for new allies. Turkey has been a NATO ally since 1952 and has for a long time played an important supporting role in the Middle East for western countries. Moreover, Turkey is still officially an EU accession country.

      Military access to the middle east was critical during the cold war for securing access to oil. Had the east ever gotten hold of the oil production of the middle east, Western Europe would have been vulnerable to an oil embargo and probably become indefensible. I don’t believe this to be the case any more. There are too many sources of oil in the world and Western Europe can pay more than China, which is as well a big importer. In some sense, I would argue that China nowadays has more urgency to have military access to the middle east than any NATO country.
      If Turkey ever joins the EU, it will be shortly before the EU ceases to exist. So far the only “large” country in the EU, that is really poor, is Poland. Turkey’s population is still growing rapidly and will in a few years be larger than Germany’s. Therefore it would have the largest weight in the council, the largest grouping in the EU parliament etc.

      1. Shane Mage

        Now that the jihadists have been beaten, there is no more flow of refugees westward, but a new and steadily growing stream of the displaced returning to their homes. The refugees freaking “Europe” out are African, not Syrian.

    1. Which is worse - bankers or terrorists

      I have been watching this for a couple of years and this is guaranteed.

      Watch Cityscape in Dubai in October, the Turks will be making their push.

    2. Steve H.

      “A short time later, the Eastern Hu returned and said: ‘You have a thousand li of unused land which we want.’ Mo Tun consulted his advisers. Some said it would be reasonable to cede the land, others that it would not. Mo Tun was, enraged and said : ‘Land is the foundation of the State. How could one give it away?’ All those who had advised doing so were beheaded.

      Mo Tun then sprang on his horse, ordered that all who remained behind were to be beheaded, and made a surprise attack on the Eastern Hu.”

  4. The Rev Kev

    There are several ways that Turkey could put pressure on the EU. As pointed out by ‘Which is worse – bankers or terrorists’, they could open up the flood gates for refugees trying to get to Europe. They could tell any bank in the EU that if they want their investments back, that they can go pound sand. Then there is the military aspect. You could actually call NATO the military wing of the EU not to put too a fine point on it. The US has two air bases in Turkey – Incirlik Air Base in Incirlik & Izmir Air Force Base in Izmir and they are also NATO commitments. Now what if they told the EU that they will close all NATO countries out and offer up leases for these bases to, say, Russia and perhaps China? That is the last thing that the EU would want. They also control access to the Black Sea via the 1937 Montreux Convention so maybe they may get more finicky about ships going through that passage. If Turkey figures that they do not have much left to lose, they may go for broke here. Trump putting sanctions on and mocking Turkey’s lira told every Turk all that they needed to know about US intentions. Now they must take the measure of the EU’s intentions.

    1. nervos belli

      Turkey has a trade deficit of 5-6% of GDP per year. Comparison the US has a 2% deficit. Yes they can declare bankruptcy and stop servicing their debt. Then their biggest market for import and export the EU, is suddenly closed. They can get all their 20 billion of oil imports per year from Iran, but how will they pay for it? How will they pay for the 25 billion of imports from China?

      Similar with exiting NATO; etc. Turkey cannot do that if Erdogan wants to avoid lots of pitchforks. The national turkish pasttime is visting the local mall on the weekends. Turkish private debt has grown sky high the last 20 years. Will these folks all suddenly stop consuming? Who are they angry against when the store shelves are suddenly empty?

      Neither China or Russia gives a toss about bases: they are not the US. Russia cares about the Bosporus but it’s not really Turkey’s to give anyways, so no one really cares: after the Bosporus there is the Aegaean See which is almost as bad a chokepoint.
      Russia and China are very stupid pipedreams

      1. The Rev Kev

        Rule # 1 of International Relations. Never push a nation into a corner without making sure that they have a ledge to climb back down on. It never ends well. Sun Tzu had the same rule in his manual for that matter.
        Turkey actually has a lot of say so on the Bosporus, especially as NATO has been militarizing the Black Sea the past coupla years but has to sail through that narrow channel to get there. Don’t forget too that the Turks know that Incirlik Air Base was used in that aborted coup even if US Forces claimed that they knew nothing about any coup being organized there.
        Qatar has thrown Turkey a $15 billion lifeline and I am sure that China and Russia would do the same too – for a price. Would do you think that price would be? If Erdogan surrenders to Trump he would be finished in the long run – which is probably what Trump wants. Do you think that a man like Erdogan would do that? No, I don’t think so either.

        1. nervos belli

          How is Erdogan less finished with China/Russia?
          For starters: China and Russia are simply not big enough to replace EU/US. Not gonna happen. While it hurt when there were no russian tourists, EU tourists are way more important.
          As for the black sea: yes they were there to support Ukraine and the ukrainian putsch. Seen any support for that lately? Ukraine of today is Georgia of 2008 and Ukraine of 2006: abject failures. And the US doesn’t care about failures.

          $16 billion lifeline. Turkey deficit 2017: 47$ billion.

          Yes, Erdogan is finished, no matter if he goes to the US or to China (Russia is small fry). Chinese money won’t really help, even if the end can be postponed a bit longer for the price of burning bridges with half the world and his most important current trade partners.
          With China there are ~$25 billion of imports. With EU about as much, however with the EU he can also export more than $25 billion altogether. Exports to pay for his chinese import bill. What will Turkey export to China? *crickets*…

          My guess is Erdogan will play everyone against each other as long as he can and not commit to anyone if at all possible, just as he’s done up to right now. However, that gameplan is harder and harder while his unsurmountable economic problems pile up.
          3-6% GDP trade deficit for 20 years, the US might be able to pull such a stunt, at a great cost, a lower end emerging market won’t.

          1. The Rev Kev

            Actually I agree with a lot of what you are saying. Erdogan is a snake who is beyond redemption. He has already demonstrated that he is quite happy to kill his own people if it furthers his ambitions. Most of the trouble Turkey is in is due to his own policies and having your son-in-law as finance minister was always a tell about what he was all about.
            Given time, there would be more cards in Turkey’s favour. It could become an exit point for Chinese products to Europe. The gas line being built will sell Russian gas to southern and central Europe. Maybe this is the reason that Trump is targeting Turkey. Going after it now before all this comes into play. But Erdogan is a wily character and the Turks a proud people so this has yet to play out.
            Still, he is not trying to make nice with the people that could help him, like Russia. For example. He is doubling down in his policy of trying to seize chunks of Syria and Iraq by reinforcing ‘his’ Jihadists in Idlib so I don’t know what will happen when the Syrian Army goes into Idlib with Russian air and ground cover and come up against Turkish forces. Now would be great time for him to pull his head in but it is not happening.

            1. drumlin woodchuckles

              The “NATO Democrats” and the “NATO Republicans” would certainly try to take America into war against Russia on Turkey’s behalf if Erdogan can get a Turkey-Russia war started.

              The “America First” Trump would dither and delay on getting America into a war with Russia in support of “our NATO ally” Turkey as long as he could. The Mainstream Democrats would accuse Trump yet again of being a secret Russia agent for trying to avoid war with Russia. The Democrats and the “Deep State” would try impeaching Trump in order to get Pence in the White House because Pence could be trusted to take America into another “Democrat War” . . . this time against Russia.

  5. John Doe

    Won’t the EU just give them all the help that they gave Greece? Why expect anything different?

  6. Thuto

    Yeah tell me about it. The rand has taken a pounding the last week, with Moody’s also ratcheting up the volume on its call for our government to cut spending (aka austerity). The hot money has also been making a run for the exit door recently in most emerging markets so whether the contagion is limited depends on where your vantage point is….

  7. Shane Mage

    This week the Emir of Qatar put up enough cash to enable Erdogan to carry out a sharp squeeze on any lira shorts. It what be useful to know how many billions more the rulers of China, Russia, and Qatar have available to prop up their newfound ally.

  8. Shane Mage

    This week the Emir of Qatar put up enough cash to enable Erdogan to carry out a sharp squeeze on any lira shorts. It would be useful to know how many billions more the rulers of China, Russia, and Qatar have available to prop up their newfound ally.

  9. DJG

    Typical EU thinking:

    –Some European politicians such as Bundestag Green member Cem Özdemir already announced that no support should come from the EU “without a return to democracy and rule of law”. But asking for political change in the context of financial assistance could dramatically backlash in Turkish domestic politics. It could be used by Erdogan as an argument that the West and the EU are part of a conspiracy against him and Turkey. The EU thus needs to walk a careful line.–

    Because dictators are so much easier to deal with. But the EU will sideline people like Cem Ozdemir.

    And I realize that a proposal to get the Turks out of Cyprus is nearly impossible, but Turkey has wasted a lot of money propping up an illegal invasion. So maybe it is time to talk about the mismanagement of the Turkish state.

  10. DJG

    Typical EU thinking:

    –Some European politicians such as Bundestag Green member Cem Özdemir already announced that no support should come from the EU “without a return to democracy and rule of law”. But asking for political change in the context of financial assistance could dramatically backlash in Turkish domestic politics. It could be used by Erdogan as an argument that the West and the EU are part of a conspiracy against him and Turkey. The EU thus needs to walk a careful line.–

    Because dictators are so much easier to deal with. But the EU will sideline people like Cem Ozdemir anyway and send in a bunch of technocrats who are worried about the impact of the currency crisis on tourism.

    And I realize that a proposal to get the Turks out of Cyprus is nearly impossible, but Turkey has wasted a lot of money propping up an illegal invasion. So maybe it is time to talk about the mismanagement of the Turkish state.

  11. Sound of the Suburbs

    If the Euro-zone’s policymakers do something sensible, it will be a miracle.

    There is a first time for everything …… maybe this it …… don’t get your hopes up.

  12. Scott1

    Picking sides in any war is better than not picking sides. The way of war now is economic. A nimble government would recognized its interest and look for the people whose interests coincide with theirs, and give them a way out.
    The Senators from North Carolina care a good deal about the Erdogan hostage accused of spying. A nation that takes your citizens hostage is an enemy. So you hurt them and hurt them till they are not an enemy or are gone.
    “Reward your friends and crush your enemies.” -Machiavelli
    “War is Deception.” Sun Tzu
    War by other means is represented by the IMF & World Bank and they are pretty good at deception.
    If if was up to me I’d put more troops on the ground that the US controls, such as Incirlik and Izmir and make them busy removing all the tactical nuclear weapons which simply ought not be there. Whatever else it takes to fully secure the Territory that the US & NATO control in the nation would be done and any benefits economically derived by Erdogan from having the bases there severely curtailed.
    Go ahead and let the IMF and World Bank give Turkey all the credit in the world, if Erdogan’s son takes the bait, great, instead of accidentally falling into the position of owning anything profitable in Greece, just do it all on purpose.
    Over and over I think the end of the conquer of Greece is Fraport that owns the leases for at least 60 years on whatever makes money on their 13, or 14 international airports.
    Don’t be giving Erdogan any F-35s if they are going to buy that Russian Missile system.
    “You throw pool ball at me, I throw pool ball at you.” Down by Law.

    Thanks

  13. Synoia

    “If it was up to me I’d put more troops on the ground that the US controls, such as Incirlik and Izmir”

    I’d cut off water, power and sewage.

    Not giving Erdogan F35 might be a mistake. He might buy a better fighter elsewhere. /s

        1. drumlin woodchuckles

          You make me feel validated. Please feel free to use that term as much as you like. Same for anyone else, if anyone else cares to.

          I hereby CopyLeft the term “Swiss Navy Knife”.

  14. VietnamVet

    The world is in an economic war. Oligarchs are shooting at each other with tariffs and sanctions. The ruling elite is also shooting at lowlifes with austerity and climate change. British Columbia is burning. This is not stable. In the nuclear era, the earth could go very bad, very fast.

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