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

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December 07, 2021

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.

 

Reference

  1. https://indianexpress.com/article/explained/turkey-currency-crashing-us-dollar-turkish-lira-7658461/

 

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