File photo: AP
File photo: AP

Opinion | The original sin behind the lira crisis

Turkey has emerged as a classic case of the complex interplay of macroeconomic forces leading to macro-imbalances and crises

The free fall of the Turkish lira and its impact on the markets has drawn attention to the puzzling nature of the mechanics of global macroeconomic crises. What explains the fastest growing G20 economy in 2017, with an external debt to gross national income ratio of only 47.8% and ranked only a distant eighth in the top 20 Developing Debtor Countries (World Bank, International Debt Statistics, 2018), slipping and becoming the latest villain in the global growth story? This is even more surprising when compared to countries that fare worse on their external debt metrics, including Kazakhstan (135.1%), Ukraine (127.8%), Bulgaria (76.4%) and Malaysia (69.6%).

Turkey has emerged as a classic case of the complex interplay of macroeconomic forces leading to macro-imbalances and crises. With an average growth rate of almost 7% since the global financial crisis, Turkey appeared to be the model European nation—fast growing and dynamic. The Turkish economy minister had claimed in March 2018 that the country was “advancing along a comprehensive and sustainable growth path". Such growth, however, was consumption-oriented and debt-fuelled, with domestic consumption leaking into imports. At the same time, the high and growing inflation rate in Turkey of 15.9% in July 2018, showed lack of export competitiveness, leading to a deepening of the current account deficit (CAD).

Given the uncertain political climate, Turkey was unable to attract foreign direct investments, which are the more sustainable means of financing current account deficits. Instead, it has had to resort to short-term “hot money flows" to fund the growing CAD, which stood at 5.6% of gross domestic product (GDP) in December 2017.

A large part of the growth was fuelled by cheap international credit, borrowed by companies and mostly denominated in hard foreign currency. Thus, Turkish external debt as a percentage of GDP rose from 36.36% in 2008 to 53.19% in 2017. More importantly, more than 70% of the Turkish debt of $460 billion was foreign and dollar-denominated. The recent fall in the lira has to be seen in the context of such long-term systemic factors, rather than short-term factors such as Donald Trump’s doubling of steel and aluminium tariffs on Turkey.

The Turkish case highlights the concept of ‘Original Sin’ as an important determinant of the extent of vulnerability of emerging economies. Economists Barry Eichengreen, Ricardo Hausmann and Ugo Panizza in 2003 used the term ‘Original Sin’ to refer to the inability of a country to borrow abroad in its own currency. Originally applied to sovereign debt, it posed a dilemma to emerging economies that were constrained in their ability to borrow externally in their home currency and found their debt obligations swell as their home currencies depreciated. As Turkey has demonstrated, new-age macroeconomic crises would likely occur as emerging market debt portfolios move away from sovereign towards the preponderance of foreign-denominated corporate debt, posing systemic risks.

A perusal of emerging market debt data reveals the ‘Original Sin’ on account of non-financial corporate debt in the post-financial crisis period ( Such dollar-denominated corporate debt poses financial stability risks to these economies and affects their investment and growth. The proportion of non-financial corporate debt to GDP for emerging markets (excluding China) has increased significantly post the global financial crisis, from 37.7% of GDP in 2008 to 44% in 2017, with nearly half of the growth in emerging market corporate debt being foreign currency debt ( This has happened even as government debt has also grown over the period from 40.5% to 48%, thus exacerbating the external debt strain.

Such foreign-exchange denominated corporate debt made sense for much of the post-crisis period when global interest rates and risk premiums were low.

However, global financing conditions are beginning to change as monetary policy is being normalized among advanced economies. As interest rates and risk premiums rise and there is an outflow of capital from emerging markets to developed economies, companies in emerging markets risk higher debt service costs. Moreover, as the dollar appreciates, the potential for an asset-liability mismatch in emerging markets corporate balance sheets arises, since the liabilities are dollar-denominated while assets are denominated in home currency terms.

What lessons can India draw from the Turkish case? India, with an external debt to GDP ratio of 20.4%, seems to be less vulnerable and is in a fairly safe spot. However, as in the case of most emerging economies, India’s non-government external debt (at 80.6% of the total) far exceeds its sovereign external debt (at 19.4%). External commercial borrowings, with a share of 38.2%, constitute the highest component of external debt, while 49.5% of India’s external debt is dollar-denominated.

India’s dollar-denominated external commercial borrowings possess the ability to increase our external sector vulnerability, especially in times of a growing CAD and worsening investor sentiment towards emerging markets. Indian policymakers may be well advised to pay attention to the phenomenon of rising corporate ‘Original Sin’.

Tulsi Jayakumar is professor of economics and chairperson-family managed business at SPJIMR, Mumbai.

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