Economic Challenges in Greece and Turkey

Economic situations in Turkey and Greece

Long before joining the Eurozone in 2001, Greece was already embroiled in financial issues albeit at smaller scale. In a bid to strengthen the economy, the Greek government had resorted to fiscal, expansionary and monetary policies especially in the 1980s (Christodoulakis, 2015). As a result, the country was hit by factors such as high fiscal and trade deficits, exchange rate crises, high inflation rates and low growth rates. It is on this gloomy economic background that Greece joined the European Monetary Union with hopes of improvement. The European Central Bank, according to Greece, would be instrumental in offering the necessary support in lowering nominal interest rates, reducing inflation, motivating economic growth, and resultant increase in private investments. Once Greece joined the Eurozone in 2001, it got a new lease of life. There were prospects of a single currency placing Greece on a level playing field with other European countries especially with regard to low interest rates. In fact, previous studies have shown that during the 2000s Greece faced similar interest rates just as Germany (Christodoulakis, 2015). The country was therefore able to borrow at cheaper interest rates than prior to 2001 and this led to increase in spending. Despite all the advantages accruing to the country, the silent fiscal problems were still in motion and remained unaddressed. Instead of working towards reducing public debt Greece went ahead to adopt a fiscal expansion approach. As a result, Greece’s annual average growth rate of government consumption expenditure was 2.8 per cent higher than that of the Eurozone.

For that reason, in the run up to to the 2008 Global Financial Crisis, Greece was already dealing with both fiscal and current account deficit. Eventually, the country lost 26 per cent of its Gross Domestic Product and debt basket expanded to 177 per cent of (GDPJuselius and Dimelis, 2018). After the crisis, Greece failed to effectively recover from the financial depression. Financial analysts have suggested that the excessive public spending financed by external borrowing was the underlying cause of the financial crisis of 2008 (Hyppolite, 2016). Further, it is contended that the financial markets had mistakenly assumed that Greece’s entry into the Eurozone would diminish the current account imbalances of member states. The aftermath of the financial crisis in Greece, not only haunt the country but also the Eurozone. While Greece contributes only 2 per cent to the Eurozone economy, her situation has bigger impact especially on foreign exchange markets (Hyppolite, 2016). To put this into perspective, Greece’s economic situation has reduced the value of the euro against the US dollar and pound, and other currencies. Questions as to whether Greece should leave the Eurozone has been mooted and considered since 2008. To this regard, there are those who believe that the country should have not joined the Eurozone in the first place. This debate was ignited by the bailout terms set by the Eurozone.

Inflation rates largely affect foreign exchange markets depending on whether it is low or high. Countries with low inflation rate will experience a stronger currency by appreciation in its value. Greece experienced high inflation rates in 2009 and 2010, which can be attributed to the financial crisis at the time. However, the inflation rate has slowed down into 2018 as result of weaker growth of global trade and other factors. The average inflation rate between the years 1979 and 2017 stands at 9.5 per cent per year. Low inflation rates attract investors who want to buy the currency for future prospects. On the other high inflation results in high interests rates in order to tame the former. Turkey on the other hand was for a long time harboring a balanced economy with an improving local manufacturing sector. As a Eurozone partner and NATO ally Turkey appeared very stable until political uncertainties emerged and the trade wars with US came to be (Yilmaz, 2018). These events have deteriorated the economic situations leading to high interest rates, high inflation rates, capital controls, and a difficult business environment. Since 2008, Turkish inflation has usually been on an upward trend. However, it has recently gone beyond 16 per cent thereby affecting the national currency and the foreign exchange market. The government has taken measures like trading of US dollars for local currency and purchase of local products. Inflation has the overall effect of local products becoming more expensive in both international and domestic markets hence a country’s products cannot compete effectively. As a result, consumers are likely to take up similar goods at lower prices from foreign competitors.

For Turkey, the recent trade wars with the United States have led to increased inflation and the Lira has weakened against the US dollar. Therefore, economic growth may be slow. In response, Turkey’s central bank has shown willingness to provide banks with liquidity. President Erdogan has even gone ahead to urge citizens of his countries to sell their dollars. Essentially, selling of US dollars is aimed at interfering with foreign exchange in favour of the Lira gaining against the dollar (Tatliyer and Yigit, 2016). When a currency like Turkey’s Lira falls, it affects international markets and specifically those of countries that trade with Turkey. Financial analysts are of the opinion that the only remedy to the weakening currency and high inflation is increasing interest rates. Large government debts drive inflation to higher levels and weaken currencies. Greece accumulated large debts after the financial crisis hence financial markets became apprehensive of their ability to repay the loans extended (Menkhoff et al., 2016). As a result of large debts that the country had accumulated and had defaulted, she had to seek bailout first from the Eurozone and the International Monetary Fund. High deficit in the current account plays a major role in the foreign exchange markets. Turkey has a vibrant industrial structure but the manufacturing industry has failed to meet the demand thus the need for importation of tons of manufactured goods (Ugurlu and Aksoy, 2017).In May 2018 Turkey’s deficit stood at 5.9 US dollars which is a high deficit in her current account. This has subsequently led to the Lira shedding its value in the international markets (Yilmaz, 2018).

As an emerging market, Turkey is experiencing slow economic growth. While the GDP was high post the 2008 financial crisis, it has slumped in the last few years to about 4 per cent. In the end the gap between the GDP growth in Turkey and the global economies financing her has widened (Polat and Payaslıoğlu, 2016). To counter this widening gap, the Lira is depreciating in the international financial markets. Turkey has recently made some political and diplomatic decisions that have had an impact on the foreign exchange market. Again, as an emerging market, investors are usually reluctant to use their currencies as investment grade currencies.

Policies by government and regulators influencing demand and supply of its currency

Interest rates

After the rise in annual inflation rate from 16 per cent to 17.9 per cent in 2018, Turkey’s central bank has indicated that it will review its monetary policies (Becker, 2018). As a regulatory body, the central bank can decide to increase interest rates so as to prevent lira from falling and causing a financial crisis. While higher interest rates are capable of hindering economic growth, it is a toll for control of inflation and supporting a local currency. The general rule is that higher interest rates result in appreciation while cutting interest rates cause depreciation. Therefore, if Turkey increases its interest rates, it will become more attractive to deposit money in Turkey and the demand for Lira will sharply rise.

IMF bailout

The Greek government took an unprecedented step to request a bailout from International Monetary Fund to the tune of 289 billion euros. It is unprecedented because of the sheer size of the amount in issue, probably the biggest bailout in world finance history. The bailout was tied to conditions such as reduced public spending. In return, Greece gets the ticket to borrow in the international market at market rates. This was one of the many reforms attached to the intervention of the IMF in order to bring back Greece as an equal player at the Eurozone and international stage. However, critics of IMF have termed the bailout as a way of extending the Greek financial tragedy as a result of the high taxes and lower spending conditions (Becker, 2018). Turkey on the other hand, has this as one of its options to control the falling Lira but has not adopted it. Argentina, also an emerging economy struggling with high debt just like Turkey had in 2018 turned to IMF in June.

Capital controls

A government can implement capital controls by preventing capital outflows from the country. The policy works best where the government has firm grip on the control of the financial sector hence it can effectively control the outflow of capital to other countries. Countries like china have been able to implement this policy where necessary (Kusuma and Lakshmi, 2019). Turkey has adopted this policy but not in its totality. Instead, the President Erdogan has urged citizens and businesses not to send money overseas in a bid to control flow of money. However, such weak methods of capital controls are not very effective because speculations can easily lead to a major exodus of money from the country. In 2015, the Greek government applied capital control policies that lasted up to 2017 when they were relaxed. At some point, banks had to be closed for two weeks by sanction of the central bank as a regulatory body. As at 2018, the capital controls had been relaxed and the limit on cash withdrawals raised from 2,300 to 5,000 euros per month.

The Central Bank of the Republic of Turkey (CBRT) introduced new measures supported by change in Turkish foreign exchange legislation. It is the first time since the 1990s, that restrictive rules on foreign exchange borrowings have been seen in Turkey (Engel, 2016). The country has for a long time been running on liberal foreign exchange regime. The new rules prohibit Turkish resident individuals from foreign currency borrowings irrespective of whether the source is locally or abroad. This move has been informed by the need to support Turkish economy against fluctuations in foreign currency.

Reserve Requirements

CBRT has contemplated and finally decided to lower the reserve requirements ratios to improve liquidity in domestic markets. Such monetary policies are targeting banks so as to increase the amount of money circulating in the market (Evans, 2017). They are usually done in response to improve inflation dynamics. Reserve requirements of banks can either be lowered or increased depending on the need by the central bank concerned.

The impact of currency fluctuation on firms and the economy as a whole

Market competitiveness

Fluctuations in currency can either be in the manner of a weak or strong currency. In international trade, weaker currencies encourage exports and causes imports to be expensive. Hence, in the long run the trade deficit of the concerned country can reduce to a certain extent. However, a strong currency has the effect of minimizing exports and in turn making exports cheaper (Ito et al., 2016). A widened trade deficit with more imports than exports will may create consequences that impact on economic growth and stability. Trade deficits therefore portend both positive and negative aspects to the economy of a country depending on the circumstances. Countries like Turkey, United State, and the United Kingdom are just but a few that are currently experiencing trade deficits. Contrastingly, china and Russia are known to have huge trade surpluses. Where a country’s currency has grown stronger against other countries, the goods it exports will appear expensive and the demand for the same will be low. In the end, low demand for goods will translates to reduced imports hence a lower GDP (Filippou, Gozluklu, and Taylor, 2018). After the appreciation of the Euro, industries in countries like Spain, Greece and Portugal were no longer capable of competing in the international market. This was because currency appreciation led to cheaper imports that could not be matched by the expensive local products. As a consequence of the above countries have become keen in trying to moderate their currencies. In that regard, China continues to devaluate its currency in an attempt to thwart uncontrolled appreciation of its currency.

Volatility in the economy

When currency constantly fluctuates, the foreign exchange market becomes very difficult to predict thereby affecting domestic and foreign trade. Trade in securities will thus be impacted since it entirely reliant on the value of the currency, which should be predictable for investors. Uncontrolled volatility of currency can have serious consequences on the foreign exchange market and the economy and investor may shy away from trading owing to high risks involved (Rogers et al., 2018). While change in currency is normal and sometimes good for the foreign exchange market, it should change in a manner that is predictable in its appreciation or depreciation. There should be identifiable patterns in its rise or fall. Economic theories suggest that prolonged trade deficits can be bad for a country’s economic outlook by affecting growth, employment and leading to devaluation of its currency. Interestingly, the US has the largest trade deficit in the world. However, it has not really felt the substantial effects of the disparity. This scenario defies the theory put forward by scholars. Arguments have been made to the extent that the US may be unaffected by the trade deficits because it is the world’s largest economy and the dollar serves as the world reserve currency. However, for smaller countries the negative consequences of trade deficits can be dire.

Small businesses are vulnerable to unstable market conditions resulting from currency fluctuations. This is because unlike big businesses, they do not have enough resource to invest in preparedness strategies in case of volatility in the currency (Omar, Mohammad and Ahmad, 2017). The lack of back up finances makes small businesses vulnerable to collapse when there is persistent fluctuation of currency value. Businesses have therefore devised ways of minimizing losses from unstable market conditions. Forward contracts can thus be used by businesses to set prices that remain stable despite the change in currency value in future. Conversely, these contracts can be detrimental to a business where the currency appreciates and they still have to adhere to the terms of the contract as previously agreed.

Inflation

A depreciating currency can sometimes cause inflation as the cost of goods rises. High inflation levels can lead to devaluation of a currency hence causing long-term problems to the economy. For countries that rely heavily on imports, high inflation can be devastating for them (Omar, Mohammad and Ahmad, 2017). The effects will be different for countries that have high levels of production and consumption since they will not be substantially affected by the high inflation. Government responses to high inflation can further make life difficult for its citizens especially where the corrective measures are tied to high interest rates. A stronger currency leads to lower inflation and imports become cheaper. Consumers will therefore spend less on foreign goods forcing local businesses to lower their prices in order to remain competitive in the market (Krugman et al., 2012). With increased disposable income in the pockets of consumers, higher living standards are achieved eventually. Additionally, cheaper imports lead to competition with local products, which will lead to local businesses having to reduce cost by either reducing staff, cutting on raw material prices (Rogers et al., 2018). Such practices may lead to increased unemployment rate as some of the local businesses that are unable to compete fairly get out of business and shut down completely.

Investment levels

A fluctuating currency affects both domestic business and foreign direct investments because all of them are dependent on stability of a currency. Economies with trade deficits make up for the shortfall in foreign currency through foreign direct investments in the country. However, foreign companies looking to undertake long-term investments in an economy will favour a predictable currency so that they minimize the risk (Rogers, Scotti and Wright, 2018). Equally, domestic businesses will find it difficult to operate with a volatile currency hence necessitating hold commodities for periods of time I anticipation of a positive change of the currency. Foreign direct investment and foreign ownership of government debt for small countries may be disadvantageous considering that her key resources will be in the hands of foreigners (Pilbeam, 2010). This can give the foreign holders of government debt leverage to push their agenda in the running of such a country to their interest.

Remittances

Remittances are currently the second largest source of inflows for developing countries. The first source is foreign direct investment. Small developing countries receive remittances from foreign countries especially from their nationals sending money back home. In some instances, these remittances have been higher than even foreign direct investment (Gudenzi et al, 2018). Again, remittances form the greater part of foreign exchange for such countries. Therefore, remittances will be affected by currency fluctuation. The level of remittances may reduce where the domestic currency appreciates and it becomes costly to send money back to one’s country. Conversely, more money will be remitted because of cheaper costs of transfer occasioned by a depreciated currency. For instance, remittances form 25 per cent of India’s foreign exchange reserves and depreciation of the rupee can result in increased remittances up to 80 percent.

Hedging strategies

Forward Contracts

A forward contract is an agreement for acquisition or sale of a given amount of foreign currency at a set price for settlement at a predetermined future date. This is a method used by businesses to manage the risk associated with currency fluctuation. It helps investors by deciding in advance the price or rate and date at which they will sell a certain amount of foreign exchange (Evans, 2017). Corporation in both Turkey and Greece have employed this strategy in doing business with less risk. Again, this risk mitigation hedging method encourages investors to put their money into business without fear of currency fluctuation. Banks act as intermediaries in forward contracts and charge commissions for the service offered (Madura, 2017). It operates like an insurance against possible currency fluctuation that may negatively affect the portfolio of an organization so that there are no additional price issues in execution of a spot trade (Becker, 2018). The down side of forward contracts is that once it is entered into a party seeking to implement and rely on it will not change their stance. It therefore means that even when the currency appreciates and the rate is higher than what is in the contract, one is bound by the contract and cannot seek to benefit from the new rates.

Cross-Currency Swaps

This is a foreign currency contract where a buyer and seller agree to swap equal initial principal amounts of two dissimilar currencies. A swap involves two people who agree to exchange liabilities in form of currencies (Filippou, Gozluklu and Taylor, 2018). The parties agree to make periodic payments over time as specified by set rules between them. Financial risks arising from potential changes in the value of the currency are a danger to international businesses that trade across borders and they will strive to overcome such risks. Currency swaps hedges the risk by ensuring receipt of foreign monies and accomplishing better lending rates. Many investors in both case study countries have used this method to reduce their risk exposure2001 (Chakravorty and Awasthi, 2018). However, currency swaps cuts both ways and parties to the deal cannot gain from currency improvements in the future not until the contract is over.

Leading and Lagging

It is the alteration of routine payment in foreign exchange transactions due to anticipated change in currency rates. Leading and lagging indicators provide certain clues on the possible change in the movement of currency exchange rates. As a result organizations can adjust payments to take advantage of the foreign exchange fluctuations2001 (Chakravorty and Awasthi, 2018). There are businesses that have significant investments overseas. Hence, fluctuation in currency will likely cost them a lot. This is manifest especially when an organization has to pay suppliers from another country in a foreign currency when their own currency has suddenly depreciated. The solution is leading and lagging by paying up debts in anticipation of currency fluctuations. Investors in both Turkey and Greece have on many occasions, applied this hedging strategy because of the nature of their currencies. The trade wars turkey has had with the US and the political uncertainties have made the Lira very volatile (Rupeika-Apoga and Nedovis Uraev, 2015). As a result, international companies in Turkey have had to utilize leading and lagging indicators to make decisions as to when to pay debts before the currency of the supplier appreciates substantially2001 (Chakravorty and Awasthi, 2018). Under the same strategy an investor may decide to delay payment based on the indicators. Such delay is important because it is done in anticipation of a drop in currency value so that when they pay their bills they do not incur heavy costs.

Conclusion

Both turkey and Greece have experienced economic difficulties which are associated with their foreign exchange markets. Despite one being an emerging market and the other, an established market the effects on them have been devastating. Turkey has experienced harsh times with ballooning debt and depreciation of its currencies forcing the country to adopt mitigation measures. On the other hand, Greece is dealing with austerity measures despite the several bailouts from IMF and the Eurozone. The Greek government has benefited from an optimum currency of the Eurozone since 2001 (Chakravorty and Awasthi, 2018). However this has not prevented the economy from sliding father downwards. The latest bailout portends positive future prospects. All in all, foreign exchange can be said to an unruly and wild horse that a country can try to tame but is sometimes decided by external factors.

References

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