The thing with economics is that an economy never gets destroyed alone. The destruction of one economy is often associated with massive collateral damage and the destruction of related economies. And Europe is getting to know this the hard way.
Turkey, which was once a liberal nation and a NATO member with a prosperous economy, has suddenly become a hotbed of jihadist terrorism under President Recep Tayyip Erdoğan’s leadership. With Islamist policies like ultra-low interest rates, Turkey is going deeper and deeper into a currency and inflation crisis. Yet, Turkey is not the only one going down. It has become a ticking time bomb for Europe and threatens to slip the entire European banking sector into a deep crisis
Eurozone banks have a fresh problem at their hands- Turkey. The ongoing currency and inflation crisis in Turkey mean that many Eurozone banks who had lent heavily to Turkish borrowers are now staring right into the risks of defaults in the background of a plummeting Lira and high inflation rates in Turkey.
How big is the Turkish crisis
Turkey is in the grip of an absolute mayhem. The Lira was trading at 3.78 against a Dollar at the start of 2018. Today, it is trading at over 13 units to a Dollar. The Turkish Lira has plunged by around 40% so far this year and remains the worst emerging market currency in the world. The driving factor behind Lira’s sharp plummet is Erdoğan’s obsession with low-interest rates and the Central Bank of the Republic of Turkey’s decision to cut interest rates three times since September.
Every time Turkey reduces interest rates, inflation starts spiraling further while the free fall in Turkish Lira gets a shot in the arm. The consumer price inflation too reached an unsustainable high of 20% in October. With a slumping Lira and decreasing interest rates, inflation in Turkey is bound to surge even further and breach the record 25% inflation recorded during a similar crisis in 2018.
Eurozone banks come under risk of Turkish defaults
Let us put it simply- Turkish businesses have borrowed heavily from Eurozone banks and much of these loans have been given in Euros. Now, as Lira plummets dramatically, the Turkish businesses are likely to find it more and more difficult to repay expensive Euro currency loans. This puts the Eurozone banks involved deeply in the Turkish economy at the risk of default by their Turkish borrowers.
In 2018, the ongoing currency and inflation crisis in Turkey had led to the European Central Bank issuing a warning about the potential risk that the plummeting Lira posed to the Euro Area banks heavily exposed to Turkey through big loans.
The Central Bank had then expressed the worry that Turkish borrowers may not be hedged against a weakening Lira and start defaulting on foreign currency loans that make up 40% of the Turkish banking sector assets. At that time, the contagion risks were somehow contained. Many Turkish banks had restricted debts of their corporate clients and Erdoğan had used state-owned lenders to bail out cash-strapped businesses by restructuring their consumer loans, including foreign currency loans.
However, concerns about the spillover effect of the ongoing economic crisis in Turkey has put Eurozone banks at risk again. On Friday, the worst-affected European stocks included four of the Continent’s most exposed banks to Turkey: Spain’s BBVA, whose shares fell by 7.3%, Italy’s Unicredit (-6.9%), France’s BNP Paribas (-5.9%) and the Dutch ING (-7.3%).
Spanish banks are the most exposed to the Turkish economy with outstanding loans of around $63 billion, followed by France ($26 billion), Germany ($14 billion) and Italy ($6 billion). Some Eurozone banks did reduce or stagnate their exposure to Turkey following the 2018 crisis. However, there are some exceptions like Spain’s second-largest lender, BBVA, which has increased its exposure to Turkey even further since 2018 and seems to have realized its mistake of getting too deeply involved in Turkey, even as its stock nosedived on Friday.
Political unrest in Turkey and how Europe might face a bigger immigration crisis
The ongoing turn of events in Turkey is likely to encourage political and social unrest in Turkey. People of the country would be, of course, unhappy with growing inflation and plummeting Lira. As everyday life becomes difficult for an average Turkish citizen, the country is bound to face signs of unrest sooner or later.
For Europe, any unrest or revolution in Turkey would be a matter of concern. Turkey is already infamous for using immigrants coming from the conflict torn regions in North Africa or Middle East countries like Syria as a bargaining chip against Europe. If tomorrow, Turkey finds itself at the risk of a major revolution, it will have no qualms in pumping more migrants into the European Continent.
In fact, many Turkish citizens may themselves be eager to leave their country in search of better destinations in Europe due to a prolonged economic crisis in Turkey. At the end of the day, it is Europe that will suffer the most due to Turkey’s misery and this makes Turkey a ticking time bomb for the European Continent.