Would Europe pay a price if Turkish economy could not find a way out of the current bottleneck?

There is now an apparent fact for the Turkish economy: it entered into a critical phase accompanied with heightening structural and institutional weaknesses, which would have enduring repercussions on the overall economic performance in the upcoming weeks if not in days. With its admiring growth rates compared to the developed countries including US and EU member states after post-2008 financial crisis period, Turkey preserved its reputation as being one of the fastest growing economies around the world. However, lack of functioning political and economic institutions -as experienced during the independence of Central Bank dispute- alongside with fragile currency-interest rate regime, led domestic and foreign investors to be doubtful about the trajectory of Turkish economy. And accordingly, as shown in the Figure-1, Turkish lira had depreciated against the US dollar by 40% throughout 2018, which put an extra burden to the banks and companies struggling with the exponentially increasing debts in foreign currencies.

Figure-1 USD/TRY Exchange Rate in 2018 (www.xe.com)

Depreciation in the Turkish lira, rising inflation and unemployment rates signify a clear status for the Turkish economy. Unless concrete policy actions are not taken now, this critical phase would end up with a time for crisis. There is no doubt that economic crisis occurred within the borders of Turkey will be detrimental for the Turkish society in the first place. Yet, we must be aware of the fact that economic turmoil in Turkey would pose contagious effects not only to the emerging markets but also to the Western economies including the Europe concerning the financial sector, trade volume and the status of Syrian refugees living in Turkey.

European Banks in the Risky Zone

According to the data compiled by Bloomberg, Turkish banks have syndicated loans from the international lenders including the European investors, which worth of 21 billion US dollars. This amount corresponds to the one-sixth of the total loans allocated to the firms located in Europe, the Middle East and Africa. Thus, it is highly probable that worsening conditions in the Turkish banking system may result in challenging times for the lenders who have high exposures in the Turkey’s financial sector due to the fact repayments of their debts in foreign currencies become considerably strenuous for the borrowers.

In addition to the syndicated loans transferred from the European lenders to the Turkish banks, another bullet may come from the fact that European financial investors have ownerships in the Turkish Banks. BBVA (Spain) made a significant investment to the Garanti Bank, UniCredit (Italy) has a partnership with the Yapi Kredi Bank and BNP Paribas (France) holds an ownership at the TEB (Türkiye Ekonomi Bankasi). Compared to the other Euro zone banks, these aforementioned banks account for a significant proportion of financial operations in Turkey. Plunging lira causes the capital structures of the banks to lose their value as well as the profits will be declined. Besides, stocks of three banks lost values in a considerable amount owing to the news spreading from Turkish market. Eventually, this increased the concerns among the European financial institutions including the European Central Bank, which has already started to play a supervisory role to overcome this hurdle.

European Exports in Question

Albeit with the recent dispute with the US, Turkey has a longstanding relations with the Western world (member of NATO, candidate to the EU and founding member of European Council). Thanks to these diplomatic ties, Turkey managed to develop noteworthy trade links with the European market. To put it frankly, Turkey and Europe are indispensable to each other as far as the latest international trade figures are concerned.

Recent European Commission’s report proves that Turkey is still a good market for European firms. Whereas Turkey is the fifth largest provider of imported goods to Europe, EU’s fourth largest export market is Turkey. Specifically, Turkey buys manufactured products, chemical goods and machinery from the European sellers. As a country level analysis, import from the Germany worths of 1.6 billion US dollars. Hence, economic bottleneck that Turkey faces would plummet the amount of imports from Europe. Furthermore, as Turkey is the notable producer of intermediate goods for the Europe, scaling down and/or closure of Turkish factories may create an undesirable environment for final good producers and well-known brands particularly in the textile sector.

New Wave of Immigration?

After its eight years of crisis and violence in Syria, more than 3.5 million Syrian citizens came to Turkey. Social and economic integration of Syrian refugees in Turkey have been maintained by the efforts of local governmental bodies, municipalities and civil society organisations. During the well-off era in Turkey, the needs of Syrian people living in Turkey were met without any apparent trouble. Nevertheless, the economic bottleneck would put the conditions of Syrian refugees in jeopardy. Deteriorating public finance and economic well-being would be detrimental for them in Turkey, which may raise the idea among them to relocate in Europe. Thus, both Turkey and Europe will feel obliged to devise a sound policy on this in order to provide a decent status to them in Turkey and prevent a new wave of immigration, which is one of the core reasons behind the heartbreaking human tragedies as the world history proved numerous times.

All in all, Turkey is now at the edge of economic turbulence due to rising inflation and unemployment rates alongside with striking depreciation of Turkish liras against US dollars. Accordingly, these economic and financial difficulties have the ability to lead Turkish economy into a stagnation through which banking sector will be adversely affected specifically. Therefore, European investors who have exposures in the Turkish financial system as well as companies in Europe that are the main exporters of goods to the Turkish market will also be in the insecure zone. To alleviate the possible ramifications of this economic disorder, it is a must for the European institutions to play their supervisory roles on Turkey and provide necessary support at least at the policy-making level. Otherwise, the bill will be paid not only by the Turkish citizens.