Rapid inflation, a tanking currency and political influence on fiscal policy has plunged Turkey’s economy into crisis. While European leaders and analysts have called on Turkey to boost interest rates and cool down its overheating economy, President Recep Tayyip Erdoğan has defiantly panned western powers for waging “economic war” on his country. ADVERTISEMENT Easy loans from European banks had helped Turkey fuel a massive, debt-funded expansion that boosted the country’s economy but also spurred rampant inflation. Those banks now face billions of euros in losses as the falling value of the lira makes Turkish debt much harder to pay off. The U.S. has a limited direct financial stake in Turkey, but a prolonged financial crisis there could spread chaos through financial markets and pose new national security challenges for the Trump administration. The crisis in Turkey comes as the country has been mired in a dispute with the United States over the detention of Pastor Andrew Brunson, which has raised the ire of President Trump Donald TrumpTrump lashes out after grand jury seated for New York criminal probe Schumer tees up vote on Jan. 6 commission bill Senators struggle to save Jan. 6 commission MORE. Here are five ways an economically battered and isolated Turkey could pose consequences for U.S. interests. Turmoil in emerging markets and tough losses for EU banks U.S. banks have a limited presence in Turkey with just $38 billion in total claims on the country, according to an analysis from Pantheon Macroeconomics. Turkey also accounts for just 1.4 percent of global GDP, which makes U.S. banks relatively safe from direct harm. “Even if all these claims were to be written off — they won't be — the impact on the U.S. banking system would be minimal,” wrote Pantheon chief economist Ian Shepherdson in a research note Tuesday. “It's bad for some European banks, whose Turkish customers are now going to struggle mightily to service their debts. But it is not a serious threat to the U.S. economy,” Shepherdson wrote. But Turkey’s financial crisis has already spawned turmoil in other emerging markets like China, where the U.S. and its allies face much larger stakes. Investment funds tracking developing economies have fallen sharply since Friday and the crisis has also roiled Chinese equity and currency markets, meaning the U.S. economy and financial markets may still be impacted. More trade tensions between the US and Turkey Turkey's economic crisis comes as President Trump has intensified a trade dispute with the country by doubling steel and aluminum tariffs on exports from Turkey. Turkey had already been impacted indirectly after the U.S. imposed tariffs on the European Union, with whom Turkey shares a customs union. Turkey, which has previously imposed tariffs on U.S. agricultural exports, responded to the U.S. actions last week by slapping another round of steep tariffs on U.S. goods Wednesday. Turkey's latest tariffs include a 50 percent tax on U.S. rice, 140 percent on spirits, 60 percent on tobacco and 120 percent on cars. "Recent developments in the U.S.-Turkey relationship threaten both countries’ economic interests and put at risk an alliance that has proven its value over decades," said Myron Brilliant, U.S. Chamber of Commerce executive vice president and head of international affairs. Crisis hinders US, EU response to Russia The Turkish financial crisis is the latest threat to the country’s ties with the U.S. and the European Union, pushing apart key allies in challenging Russian aggression. EU leaders have called on Erdoğan to accept interest rate hikes and other measures to stabilize Turkey’s economy and ween it from its reliance on foreign debt. Erdoğan has refused to do so and blamed the crisis on western “economic terrorists,” including the U.S. Trump has also imposed financial sanctions on two top Erdoğan officials over the detainment of Brunson. He also signed Tuesday a massive defense spending bill that bans the sale of F-35 fighter jets to Turkey, which Ankara has helped develop. Erdoğan has responded by rallying Turks against the U.S. and seeking closer economic ties with Russian President Vladimir Putin. The deepening divide among NATO members could weaken attempts to respond to various Russian actions such as Kremlin-backed cyber attacks, electoral interference in various countries and its occupation of Ukraine. Further unrest in the Middle East, complicating life for Trump Turkey has been a key member of the international coalition fighting the Islamic State in Iraq and Syria (ISIS), and its woes have the potential to disrupt the fight at a pivotal moment. Turkey already stalled momentum in the fight against ISIS when the country earlier this year launched an offensive against Kurdish forces in northern Syria. That forced U.S.-backed Kurds fighting ISIS to leave the fighting and help their brethren, pausing the battles against the terrorist group in the Middle Euphrates River Valley. Ankara considers the Kurdish fighters as terrorists connected to outlawed Turkish Kurdish separatists, while Washington sees them as the most effective native fighting force on the ground in the Syria. Turkey and the United States appeared to reach a breakthrough in their impasse over the Kurds when they reached an agreement in June on a “Manbij Roadmap” that sets the withdrawal of the Kurds from that city. The new tensions threaten to derail that progress just as the coalition plans a final push to rout ISIS, but officials have downplayed any connection. “We've seen no change in our relationship with our Turkish allies,” U.K. army Maj. Gen. Felix Gedney, the coalition’s deputy commander for strategy and support, told reporters at a Pentagon briefing Tuesday. So what happens to Güllen? One of the root causes of U.S.-Turkish tensions has been a Muslim cleric living in Pennsylvania. Erdoğan blames Fethullah Gülen for the 2016 failed coup attempt against him and has demanded the U.S. immediately extradite the cleric. But the U.S. has been unwilling to do so, citing Gülen’s due process rights. Gülen is a legal U.S. resident who has lived in rural Pennsylvania since 1999 after fleeing Turkey. He and Erdoğan were allies before Erdoğan turned on him, and Gülen denies any responsibility in the coup.<doc-sep>First, it has a high level of debt due for repayment in the near future - loans that have to be repaid and the money borrowed anew. To use the language of the financial markets, the debt has to be refinanced. Credit rating agency Fitch estimates that Turkey's total financing needs this year will be almost $230bn.<doc-sep>Turkey’s currency crisis is by no means a black swan event as trouble had been brewing in the country for several months. Still, fears of a spillover effect from the troubles in the world’s 17th largest economy played havoc with the global financial markets Friday as panicked investors ran for cover. Turkey is an emerging-market economy with a population of roughly 80 million. It is a founding member of the Organization for Economic Cooperation and Development and is among the early signatories of the General Agreement on Tariffs and Trade, an international pact that promotes reducing trade barriers. It is also a part of NATO, making it a key military ally of the U.S. Historically, the country has parlayed its geographic location to serve as an important bridge between the East and the West. Stratfor Yet, the image the world holds of Turkey in recent years has been colored by headlines about President Recep Tayyip Erdogan’s authoritarian rule and mounting criticism over his government’s inept handling of the economy. Making matters worse, Ankara is in the midst of a diplomatic row with Washington over its detention of pastor Andrew Brunson on espionage charges. In addition to sanctioning two Turkish officials last week, President Donald Trump on Friday announced via Twitter that he has authorized doubling tariffs on steel and aluminum imports from Turkey. Iron and steel exports to the U.S. totaled $885 million in 2016, according to the Office of the U.S. Trade Representative. In the most visible sign of deteriorating confidence in the country, the Turkish lira USDTRY, +0.02% sank to its lowest level against the U.S. dollar with the buck buying 6.42 lira versus 5.55 earlier. The plunge in the currency could easily push Turkey to the brink given its elevated debt burden and perhaps force the government to seek a bailout. Turkey’s external debt reached $466.67 billion, or 53% of its gross domestic product, at the end of March with about one-fourth in short term debt which will come due within the year, reported Anadolu Agency, a government-run news agency. In comparison, Deutsche Bank estimates Turkey’s foreign currency-denominated debt at closer to 70% of GDP. Read:Cost to insure Turkish debt spikes as Turkey teeters on brink of currency crisis The U.S. dollar, as represented by the ICE dollar index DXY, +0.05% jumped 0.9%, in part due to a belief that Turkey’s problems are not expected to have a major impact on the U.S. Read: Dollar index jumps to 14-month high as Turkey’s lira gets rocked to historic low See: 3 reasons the selloff in Turkey’s lira matters for markets all over the world Meanwhile, U.S. stocks fell sharply as Turkey underscored global risks at a time when major central banks, led by the Federal Reserve, are shifting to tighter monetary policy regimes. The S&P 500 SPX, +0.19% shed 0.7% to close at 2,833.28 and the Dow Jones Industrial Average DJIA, +0.03% fell 0.8% to 25,313.14. Read:Stocks fall as Turkey’s currency crisis spotlights global risks See:Here’s what it will take to push Wall Street’s buttons There are also contagion fears, particularly for Europe given its nearly $180 billion in trade with Turkey as well as sizeable loans to the country. European Commission All European stock markets closed lower with the Euro Stoxx 50 SX5E, -0.11% falling 2%. Read:European stocks end sharply lower as Turkey contagion fears spook investors See:FTSE 100 ends lower as Turkey contagion angst grows, but retains slight weekly gain Gold US:GCZ8, which tends to gain when investors are unwilling to take on risk, did not benefit much from the developments in Turkey with the precious metal settling almost unchanged on Friday at $1,219 an ounce. Read:Gold closes slightly lower as dollar’s jump outweighs Turkey contagion fear<doc-sep>With financial turmoil in Turkey roiling the country's assets, analysts are busy contemplating which other countries could be exposed and what this could mean for international investors. Turkey has been in economic difficulties since the start of the year. Its currency has lost about 33 percent of its value on the back of large fiscal stimulus, growing inflation and a hefty current account deficit. There's also been intervention from President Recep Tayyip Erdogan on the central bank's policy decisions which continues to surprise investors and accentuate the fall in the currency. European banks Media reports suggested Friday that officials at the European Central Bank (ECB) are concerned over southern European banks, which have lent significant amounts of money in Turkey. This suggests that investors holding stock in European banks could be at risk. The ECB declined to comment on the reports. Data from the Bank for International Settlements (BIS) — often called the central bank of central banks — shows that Spanish banks are owed $83.3 billion by Turkish borrowers; French lenders $38.4 billion; and banks in Italy are owed $17 billion. Regulators in Europe are reportedly worried that the weaker currency will lead to defaults in foreign loans. Shares of , BNP Paribas and BBVA fell around 3 percent Friday morning, after being cited as the European banks with the highest exposure to Turkey. This dragged the wider market down with the pan-European Euro Stoxx 600 down 0.7 percent by 9:00 a.m. London time and the banking index dropping 1.3 percent. Carsten Hesse, a European economist at Berenberg, said in a research note that some euro zone banks are under pressure "due to their direct equity exposure to Turkish banks or participation in syndicated loans — a loan offered by a group of lenders." Japan, US When asked about the impact of the ongoing troubles in Turkey, Timothy Ash, a senior emerging markets strategist at Bluebay Asset Management, told CNBC via email that "it's likely mostly banking exposure at this stage." However, he added that exposure is "pretty international." "European, U.S., Japan, China, Middle East — everyone," he added. The BIS cross-border figures also show that Japanese banks are owed $14 billion, U.K. lenders $19.2 billion and the United States about $18 billion. Lira continues to plunge On Friday morning, the lira hit another record low, plunging to 5.9976 against the U.S. dollar. Erdogan himself spoke out to try to calm the economic storm, saying Friday morning that Turkish citizens should not be worried about the weaker currency. "There are various campaigns being carried out. Don't heed them," the president said. "Don't forget, if they have their dollars, we have our people, our God. We are working hard. Look at what we were 16 years ago and look at us now," Erdogan told supporters. 'Modest' impact Despite Turkish fears spreading to the rest of Europe there were analysts still fairly sanguine on the risks for the global economy and foreign investors. Roger Jones, head of equities at investment fund London and Capital, noted there could be repercussions for European insurers, although "modest." "Several European banks plus insurers have exposure (to Turkey) but it is modest in the context of the overall group. Overall, Turkey will be a small component of European company profits with no specific name stating out as overly exposed," Jones told CNBC via email. "As far as the U.K., HSBC has exposure to Turkey but it is modest in the context of the group, as does Aviva," he noted regarding U.K. stocks in particular. Bond markets Meanwhile, the economic woes in Turkey could also bring problems for European sovereign debt, potentially affecting bond investors and governments who rely on the debt markets to fuel their spending plans. "I don't expect any euro zone country bond yields to really suffer due to Turkey, but on the margin the countries in the euro zone with the highest bond yields would probably be the ones who could feel some minor impact," Hesse from Berenberg bank told CNBC via email. He mentioned that in this case Greece and Italy could be hit as well as Spain, "due to its higher-than-average bank exposure to Turkey." However, Ash played down risks that Turkey could become a sovereign debt problem. "I don't see huge global contagion. Turkey is still a relatively small economy – (worth) $850 billion, and unlikely this will be sovereign debt event," Ash said in an email. Wait-and-see mode<doc-sep>
The free fall in the Turkish lira has stoked fears of an economic fallout that could spill over into other emerging markets and the banking systems in Europe. Turkish President Recep Tayyip Erdogan blamed the plunge in the currency on "an operation against Turkey" and dismissed suggestions that the country's economy was facing troubles. But strategists from J.P. Morgan Asset Management said the NATO member has found itself "in the midst of a perfect storm" of worsening financial conditions, shaky investor sentiment, inadequate management of the economy and tariff threats from the U.S. "Turkish assets have been under severe pressure," the strategists wrote in a Friday note. "While Turkey makes up a small percentage of the global economy and financial markets, investors are worried about the issues in Turkey causing damage in other markets around the world, particularly Europe." In the immediate term, policy decisions out of Washington have sparked Turkey's currency crash: The lira plunged as much as 20 percent against the dollar on Friday after President Donald Trump said he approved doubling metals tariffs on Ankara. But the cracks in Turkey's economic foundation were already spreading before the American president made his move. How did Turkey get here? Turkey has in recent years been one of the fastest-growing economies in the world, even outperforming economic giants China and India last year. In the second quarter of 2018, the country reported 7.22 percent growth in its gross domestic product. That expansion, however, was fueled by foreign-currency debt, analysts said. At a time when central banks around the world were pumping money to stimulate their economies after the global financial crisis, Turkish banks and companies were racking up debt denominated in U.S. dollars, they said. (Turkish President Recep Tayyip Erdogan) is here to stay, and markets don't have confidence in him. That's a dangerous mix. Richard Briggs CreditSights analyst That borrowing, which fueled consumption and spending, resulted in Turkey running deficits in both its fiscal and current accounts. The former happens when government spending exceeds revenue, while the latter essentially means a country buys more goods and services than it sells. The country's foreign currency debt now stands at more than 50 percent of its GDP, according to estimates by the International Monetary Fund. Implications of Turkey's debt Turkey is not the only economy with "twin" deficits and high amounts of foreign currency debt. Indonesia, for example, also runs fiscal and current account deficits and its foreign currency borrowing is roughly 30 percent of GDP. But unlike Indonesia, Turkey doesn't have large enough reserves to rescue the economy when things go wrong, said Richard Briggs, an analyst from research firm CreditSights. According to Briggs, Turkey's reserves are notably low compared to its $181 billion in short-term debt denominated in currencies other than the lira. On top of that, much of the foreign currency in Turkey is held by banks, and those funds could be withdrawn by customers, he added. That means when the lira falls, Turkey may not be able to buy up its currency to prevent it from spiraling further. If that situation worsens, the country would have to find other ways to finance its debt, including possibly getting bailed out by the International Monetary Fund. Economic mismanagement To many analysts, Turkey wouldn't have gotten into the current predicament if its central bank had been left to do its job. The Turkish economy has been "overheating" with inflation — at 16 percent in July — way exceeding the central bank's target of 5 percent. Raising interest rates could have helped to stem such a massive increase in consumer prices: Higher rates tend to attract foreign investors, who would need the lira to buy Turkish assets. That could in turn support the currency, which makes imports cheaper and lessens the burden of paying back foreign debt. But Erdogan has said he's in favor of lower interest rates to continue driving growth. His influence over the country's central bank has undermined investor confidence, experts have said. "President Erdogan continues to prioritize growth and lower rates which will extend the current crisis, rather than allowing the economy to rebalance. He is here to stay, and markets don't have confidence in him. That's a dangerous mix," Briggs wrote. What's next for Turkey?