Turkey’s currency has been declining to all-time lows against the US dollar and the euro in recent months as President Recep Tayyip Erdogan presses ahead with a widely criticized effort to cut interest rates despite surging consumer prices.
As a result, families are struggling to buy food and other goods and the Turkish lira has lost around 40 percent of its value since the start of the year, becoming one of the world’s worst-performing currencies.
How the value of a currency is determined
In most countries of the world, the currency’s value is determined by floating exchange rates. In this system, the value of a currency is determined by the basic economic concept of Demand and Supply.
A currency with more demand has a higher value. As the exchange of different currencies takes place in the Exchange market, the demand of each currency in the market determines its value.
In this process of value determination, the government or authority of a country has no or little control. Even though government or the central bank of the respective country does interfere when the currency is unstable or performs poorly.
The central bank of a country (RBI in India) also maintains a large reserve of foreign currency to deal with any kind of problems for Local currency in the Foreign Exchange Market. As mentioned earlier authorities of a country do intervene when they sense a bad time for their currency.
HOW DOES RBI CONTROL CURRENCY FLOATING IN THE INTERNATIONAL MARKET
The demand for the US dollar is high since India is importing more products from the US than exporting. In such a scenario, the demand for the US dollar will increase since more dollars will be paid to the US while buying goods from them.
And from the Indian side, more dollars will have to be bought from Foreign Exchange Market to pay for these goods.
As such demand for US dollars will increase as compared to the Indian rupee and hence their value. But if the value of the Indian Rupee falls a lot, the government will step in.
Immediately, they will try to reduce the supply of the Indian rupees ( to compensate for the low demand). They will buy the Indian rupee from the market using US dollar reserves held by it.
Why is the lira crashing?
Mr. Erdogan’s unusual monetary policy principles have been the main wrongdoer behind the rising supply of lira. The Turkish President has been a fan of low-interest rates, which he thinks is crucial to boosting economic growth and bringing down inflation. It should be noted that the central bank influences interest rates by regulating the money supply. To lower interest rates, it flushes the loan market with fresh money.
Many economists do support the reduction of interest rates when they believe the economy is not operating at its full capacity.
But once an economy reaches its full capacity, economists argue, any further lowering of interest rates will only cause inflation. Mr. Erdogan, however, seems to believe that no amount of lowering of interest rates will cause prices to rise. has argued that higher interest rates are the reason prices in the economy rise as they add to costs. His regime also believes that low-interest rates will bring down inflation by boosting growth which increases the supply of goods. So, according to Mr. Erdogan’s logic, a central bank can print unlimited amounts of currency and still avoid hyperinflation by sufficiently boosting growth.
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