The Turkish Collapse and its Effect on Europe

The crash in the value of the Turkish lira is not really a surprise. President Erdogan has been following loose monetary policies despite receiving warnings from several monetary experts. In a way, this economic turmoil has been self-inflicted. Turkey has increased its money supply to about 300% in the past seven years! The rationale behind this reckless policy is that the interest rates are being kept low in order to boost the economy. Time and again, economic history has shown that sovereign countries cannot simply keep on printing money if they do not have the economic fundamentals to back the monetary expansion.

However, the Turkish monetary expansion had less to do with economics and more to do with politics. President Erdogan had survived a planned military coup and wanted to cement his position in local politics. This is the reason why he kept printing more and more money to give handouts in order to gain political leverage. Erdogan increased subsidies by more than 20% in several important economic sectors. The brutal power battle had scared away businesses and Erdogan was trying to create a false image of a nation which has a fledgling economy by printing more money. Erdogan also drastically increased pensions to a large section of the population. Once again, this was done in order to cement his position.

Until now, the world was largely uninterested in Turkey. The assumption was that any loose policies being followed by Turkey will only create problems for Turkey itself. It was widely believed that the rest of the world would continue to be unaffected. However, this belief has been shaken to the core in the recent crisis. The currencies of emerging markets took a huge hit thanks to the Turkish crisis. However, more importantly, this crisis is expected to have a huge impact on the already fragile Eurozone economies.

In this article, we will have a closer look at the possible impact that the Eurozone faces thanks to this crisis.

Trading Partner

The Eurozone is Turkey’s largest trading partner. Germany, Italy, Spain, and France all have deep trading relations with Turkey. Turkey is at the center of Europe and the Middle East and hence has an important geopolitical location as far as trade with Europe is concerned. The country also has a huge population of 80 million which makes it an important marketplace. The point to be understood is that Turkish consumers use a lot of European products. If the economy of Turkey were to go into recession, this consumption would be drastically reduced. As a result, sales of European products will also be reduced. Obviously, this will have an adverse impact on the economy of Europe as well.

Banking Exposure

Apart from trade, the capital flows between Europe and Turkey are also interconnected. Turkey has been borrowing a lot of money to make up for its monetary excess.

European banks have been the ones lending to it. Recent estimates by the Bank of International Settlements have shown that Turkey owes $84 billion to Spanish banks. Turkey also owes $40 billion to French banks and $20 billion to Italian banks. Smaller Eurozone countries have also lent money to Turkey. In all, Turkey owes more than 20% of all its debt to Europe. It is therefore obvious that if the economy of Turkey collapses, the European banking system would also take a hit.

Since the European banking system is already in turmoil, it is feared that the Turkish crisis could end up sparking a way of defaults. The world has now started taking this crisis seriously.

In terms of size, the Turkish crisis is bigger than the Greek crisis and almost at par with the Italian crisis. This is the reason why the Eurozone has a vested interest in keeping the Turkish economy afloat.

Refugee Support

Turkey has agreed to provide support to Syrian refugees. This is reducing the flow of Syrian refugees to European nations.

Europe is already facing a massive refugee problem. If the Turkish economy collapses, it is likely that Syrian, as well as Turkish refugees, will start flooding Europe. This would lead to massive expenses for the European governments.

Also, the political situation in Europe is turning fragile because of the increase in the number of refugees.

Once again, Europe is dependent upon Turkey to keep the refugee crisis in check. This is another reason why European leaders should be very concerned because of the present crisis.

The Problem with a Bailout

Turkey has two possible ways wherein it can solve the crisis. It is unlikely that either will be followed.

Firstly, Turkey can raise interest rates to bring the monetary situation under control. However, this will cause deflation in the short run. This would hurt President Erdogan’s image. This is the reason, it is unlikely that this policy will be followed even though from an economic point of view, it is the right thing to do.

Secondly, Turkey could go to the IMF to borrow money. Once again, IMF would impose austerity measures on Turkey. This is likely to hurt Turkish pensioners and public sector workers. This too will not be acceptable to Erdogan. Hence, this option too will not be followed.

The problem that Europe faces is that if it bails out Turkey, it encourages reckless behavior being undertaken by Erdogan. On the other hand, if it does not bail out Turkey, it is likely to face a significant economic impact. It is like choosing between the devil and the deep sea!