Inflation Playing a role

Inflation remains the single biggest threat to currencies. Typically, central banks are mandated to maintain price stability. But, depending on the circumstances, inflation can start to creep higher. Examples of inflation leading to currency crisis include the famous inflation in Zimbabwe and the more recent episode in Venezuela.

Debt playing A role

It is often said that debt fuels the economy. Under general circumstances, governments tend to keep a close watch on the amount of borrowing in the economy. When lenders learn about potential factors that could lead to a cut in the credit ratings, the borrowing costs rise. This can eventually lead to a freeze in borrowing due to the higher interest rate demand by lenders.

Political stability playing a role

Currency crisis can occur due to political reasons as well. An economy needs to have a stable political environment. This is good for overseas investors as well as for the economy to grow. When there is political infighting or riots against the government, it can lead to instability. This, in turn, spurs foreign investment coming into the economy, resulting in an indirect impact on the currency’s value.

Economic Factors playing a role

The global economy also plays a role in the currency crisis. When there is a faltering economy, central banks respond by lowering interest rates. The open markets set the value of an exchange rate in a free-floating exchange rate policy. This can get difficult in case an economy is following a fixed rate regime. Defending the exchange rate peg can become a costly affair.

• 1998, RUB Crisis

The Russian financial crisis (also called ruble crisis or the Russian flu) hit Russia on 17 August 1998. Declining productivity, a high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, fatal financial imprudence and a chronic fiscal deficit were the reasons that led to the crisis. During ruble crisis, the nation had to devalue its exchange rate. One of the reasons that led to the crisis was falling productivity amid a higher fixed exchange rate. The Russian central bank had to intervene in the markets to devalue its currency as a result. The crisis got to a point that Russia had to seek loans from the International Monetary Fund.

• 2015, CHF De-peg

In 2015, the Swiss National Bank shocked the FX markets by announcing that it will de-peg the EUR and the CHF exchange rate. The SNB had, for years, maintained a floor on the EURCHF exchange rate. For a currency that was pegged to the euro, the CHF appreciated more than 30% on the day. This was unprecedented because currency crises typically lead to a devaluation of the currency.

• 2018, TRY Devaluation

In the 2000s, the Turkish government enacted a series of political and economic reforms to attract foreign investment. After the 2008-2009 Global Financial Crisis, Turkey experienced a rapid influx of foreign capital. It was partly due to the reforms and also to the fact that most large countries lowered interest rates after the crisis to promote investment and boost aggregate demand.

In 2018, the Turkish lira (TRY) fell by almost 45% against the US dollar (USD). Between 2010 and 2018, Turkey experienced average GDP growth of around 6.5%. During the period, Turkish businesses and banks borrowed huge amounts of money from international investors. Most of the debt was dollar-denominated, which meant that Turkey was exceptionally susceptible to US monetary policy. The TRY became strongly devalued as it fell to 4 USD per Turkish lira. The exchange rate was about 1.34 USD/TRY back in 2005.

The impact of the devaluation in the Turkish lira also reached across shores into Europe. Because Europe had a significant amount of investment in Turkey, the currency crisis led to a decline in European equities as well.