Explained: Turkey’s currency is crashing. What’s the impact?

Why in news?

Inflation has soared by more than 21% in Turkey and many people in this country are struggling make both the ends meet.

What is the present situation in Turkey?

Turkey’s currency (Lira) has been plunging to all-time lows against the U.S. dollar and the euro in recent months.
Turkish lira has lost around 40% of its value since the start of the year, becoming one of the world’s worst-performing currencies.
As a result, families are struggling to buy food and other goods.
However, President Erdogan presses ahead with a widely criticized effort to cut interest rates despite surging consumer prices.

How interest rate affects economic growth and inflation?

Money is a commodity. Its value changes as per demand supply equation.
The government of the day is generally responsible for promoting economic growth. On the other hand the central bank is responsible for controlling the inflation.
Interest rate and economic growth - To boost economic growth money should be made available to the people.
To achieve this interest rate has to be reduced.
Now people can borrow more from the bank and invest the borrowed money in business to make profit.
This promotes economic growth due to job creation, increased production and importantly more purchasing power with the people.
Interest rate and Inflation - When people borrow more there is a tendency to spend more. Purchasing power of people increases.
When supply of goods remains constant and money supply increases demand supply equilibrium alters it leads to inflation.
Now interest rate has to be increased so that more money goes into the hands of bank rather being available with the general public.
So interest rate has to optimised so that there is a stable economic growth and a manageable level of inflation.

What led to the present situation in Turkey?

Erdogan’s Policy – Erdogan, the long standing president, is of the religious view that interest rates as “evil.”
He had argued that high interest rates cause inflation contrary to what economists generally say.
He has been pushing for low borrowing costs to stimulate the economy, boost growth and exports, and create jobs.
Banks response - Turkey’s Central Bank has repeatedly cut borrowing costs in line with Erdogan’s wishes.
As a result, the Turkish lira, which had barely recovered from a currency crisis in 2018, has been weakening to record lows against the dollar and the euro.
Inflation is especially acute in Turkey because of the government’s unorthodox policies.
Lira plummeted to an all-time low of 14 Lira against one US dollar.

What are the impacts of current crisis?

The inflation rate stands at a stunning 58%.
Turkey relies on imported raw material.
The devalued lira is driving prices higher. It is making imports, fuel and everyday goods more expensive in Turkey.
Every morning, long lines form outside kiosks selling bread a lira cheaper than in bakeries and shops.
The economic crisis has also led to brain drain making experts moving out of the country.
The rate cuts have raised concerns over the bank’s independence
The country’s unconventional monetary policy has spooked foreign investors, who are dumping Turkish assets.
Turkish citizens are rushing to convert their savings to foreign currencies and gold to protect them from inflation.
Turkey is focused on growing the economy rather than controlling inflation
But now even growth is highly questionable at this point because we are going to see more contraction coming as a result of the panic and uncertainty and escalating costs coming from this crisis.

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