The strong dollar and the Turkish economy

Turkish economists have written and talked about the importance of the exchange rate on the economy so much that every housewife or cab driver, in fact just anyone who proudly calls herself a Turk, is aware of the main arguments.



For one thing, since Turkey imports around $175 billion of intermediate goods, producers pass on a depreciating Turkish Lira to their prices. Moreover, Turkish corporates’ foreign currency (FX) liabilities are $180 billion higher than their assets. Such a high “open position” means that many Turkish firms are vulnerable to lira depreciation.



Not all about a stronger dollar is grim. A less valuable lira would make Turkish goods relatively cheaper. The resulting rise in international demand would eventually surpass the price effect and the total value of exports would increase, at least in theory. In economics, this is called the J-curve effect.

When Turkey economists talk about the exchange rate, they don’t look at just the euro or the dollar against the lira, but instead a “basket,” which is the average of both exchange rates. This simple method for smoothing out movements in the euro-dollar exchange rate used to make sense until recently.



But the dollar has been appreciating against the euro since spring 2014, with the lira holding relatively better against the euro. Recent events such as the European Central Bank’s announcement of its own quantitative easing, worries that Greece’s exit from the Eurozone could lead to a break-up of the common currency area and stronger U.S. data cementing the Federal Reserve’s first rate hike in the next few months have all strengthened this move.



Analysts expect this trend to continue, with some forecasting the dollar to be more valuable than the euro eventually, so it is useful to go over the impact of a falling euro-dollar exchange rate on the mechanisms I outlined above. For one thing, while Turkey receives its export revenues more or less equally in dollars in euros, it pays for almost two-thirds of its imports in dollars. As a result, the currency composition of Turkey’s trade is not working in the country’s favor.



In any case, it is better to look at the real exchange rate, which takes into account the increase in prices as well, to analyze the attractiveness of a country’s exports. Because of Turkey’s high and persistent inflation, its real exchange rate has depreciated less than its nominal exchange rate. And since other emerging market currencies have been losing value against the dollar as well, the real exchange rate based on developing countries has fallen even more modestly.



As for the corporates’ FX debt, about 55 percent of Turkey’s $400 billion of external debt, which includes both public and private debt, is in dollars. While only companies earning FX can borrow in FX from domestic banks, there is nothing stopping a firm earning euros from borrowing in dollars. In fact, most of the $155 billion of FX loans are in dollars. Economics consultancy Capital Economics calculated Turkey’s dollar debt to be almost 40 percent of its GDP, second only to Chile, and advised it clients “to keep a close eye” on the country.



India’s Central Bank governor Raghuram Rajan recently warned Indian companies that borrowing in dollars “is like playing Russian roulette.” For Turkish companies, given the currency composition of their assets and liabilities, there seems to be more than one bullet in the gun.