The ECB has already warned once about the potential impact a plummeting lira could have on Euro Area banks heavily exposed to Turkey’s economy.
Turkey is in the grip of another big wave of its multiyear currency crisis. The value of the lira against the dollar has plunged by almost 40% so far this year, making it the worst performing emerging market currency. The currency is currently trading at just over 13 units to the dollar, compared to 7.44 in January and 3.78 at the start of 2018. On just one day this month (Nov 23), the currency plunged almost 20% before recovering slightly. The main cause of the collapse was the Central Bank of the Republic of Turkey’s decision to reduce interest rates for the third time since September, despite a slumping lira and surging inflation.
At the height of the last big wave of Turkey’s ongoing crisis, in August 2018, the European Central Bank issued a warning about the potential impact the plummeting lira could have on Euro Area banks heavily exposed to Turkey’s economy via large amounts in loans — much of them in euros — through banks they acquired in Turkey. The central bank was worried that Turkish borrowers might not be hedged against the lira’s weakness and would begin to default on foreign currency loans, which accounted for 40% of the Turkish banking sector’s assets.
In the end, the contagion risks were largely contained. Many Turkish banks ended up agreeing to restructure the debts of their corporate clients, particularly the large ones. At the same time, the Erdogan government used state-owned lenders to bail out millions of cash-strapped consumers by restructuring their consumer loans, many of them foreign denominated, and credit card debt.
But concerns are once again on the rise about European banks’ exposure to Turkey. On Friday, as those concerns commingled with fears about the potential threat posed by the new omicron variant of Covid-19, Europe’s worst-affected stocks included the four banks most exposed to Turkey: Spain’s BBVA, whose shares fell 7.3% on the day, Italy’s Unicredit (-6.9%), France’s BNP Paribas (-5.9%) and the Dutch ING (-7.3%).
The collapsing lira is almost certain to fuel even higher inflation in Turkey. In October, consumer price inflation in the country was already at an eye-watering 20%. That’s still not as high as the 25% peak registered in 2018, but it is likely to go a lot higher as the lira weakens. As prices soar, further eroding the savings and incomes of many Turks, so too will the risk of social and political unrest. Another cause for concern is that a weaker lira will make it even harder for businesses already battered by the fallout of the virus crisis to repay their foreign-denominated debts.
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