The motivations that underlie a country’s decision to borrow money are not always strictly economical. Take Turkey, whose ratio of gross external debt (all public and private sector debt) to GDP has increased from 39% in 2012 to 52% today. Turkish President Recep Tayyip Erdogan has been pushing to increase investment by increasing available credit to spur economic activity. This is a political goal, though one motivated by economic objectives. The problem Erdogan encountered, however, is that there was not enough domestic capital available to meet Turkey’s lending needs.

When a country chooses to borrow, it has two sets of choices. First, should it borrow domestically or from abroad? Second, should its debt be denominated in domestic or foreign currency? Each option has its own implications, but it is particularly constraining when a country borrows from abroad in a foreign currency.

When debt is borrowed in another country’s currency, the borrowing country no longer has the option to depreciate its own currency through monetary policy in order to decrease the relative value of its debt. The other risk involved in foreign currency borrowing—beyond the risk already inherent in borrowing—is that the borrower’s currency will decline in value and increase the cost of debt service.

For example, if a country borrowed $100 million at 10% in US dollar-denominated debt, it would owe $10 million per year. If the exchange rate between the borrower’s currency and the dollar is 2 to 1, then that $10 million is equal to $20 million of its own currency per year. If its currency depreciated and the exchange rate to the dollar became 4 to 1, it would still owe $10 million, but in terms of its own currency, that figure would have doubled to $40 million in debt service per year.

Turkey’s Dilemma

The pitfalls are clear, but for Turkey, domestic borrowing is not a sufficient option. Banks lend money that is entrusted to them in the form of deposits. The quantity of deposits is determined by a society’s proclivity to save. If deposits are lacking, then the bank will have only so much domestic capital to lend. Herein lies Turkey’s dilemma: The government wants to boost economic growth by extending greater credit to encourage investment, but there isn’t enough domestic capital in the banks to meet these goals. Turkey’s savings rate, at about 15% of GDP, is lower than that of other economies categorized by the International Monetary Fund as being at a similar stage of development.