Berlin – The threat of economic chaos in Turkey has set alarm bells ringing across Europe, rattling financial markets and emerging economies, but leaving EU leaders with few options to head off the risk of a wider international financial crisis.

A measure of calm returned to markets this week after the Turkish lira managed to claw back some of its losses against the dollar after the nation's central bank unveiled measures on Monday aimed at addressing the country's currency crisis.

Alarm bells throughout Europe

"The main risk to the euro area from economic chaos in Turkey is political," said Claus Vistesen, chief economist with the research group Pantheon Economics. "As far as Europe goes, however, stability in Turkey is critical."

Apart from threatening a EU deal spearheaded by German Chancellor Angela Merkel with Ankara aimed at stemming the flow of refugees making their way to Northern Europe, chaos in Turkey – a NATO member state – could undermine the military alliance's unity.

The European Central Bank has also expressed concerns about the exposure of eurozone banks to the turmoil to Turkey, with financial houses in Spain, Italy and France holding the highest share of assets in Turkey.

Calls on Ankara for urgent action

Meanwhile, signs have emerged of contagion spreading from Turkey to other emerging economies with currencies in EU member states in Central and Eastern Europe facing pressure as the lira crisis has deepened, adding to Europe's dilemma on how to deal with turmoil in Turkey.

Analysts say a deepening crisis could result in Turkish President Recep Tayyip Erdogan forming even closer ties with Russian leader Vladimir Putin and make Ankara reluctant to cooperate with NATO – especially as both nations are now targets of US sanctions.

Merkel declared this week "the economic destabilization of Turkey" was in nobody's interest.

Two of Turkey's leading business associations – the Turkish Industry and Business Association (TUSIAD) and The Union of Chambers and Commodity Exchanges (TOBB) – have also called on Ankara to take urgent action to strengthen relations with the nation's "most important economic partner", the EU.

But ending the upheaval in Turkey is largely out of European leaders' hands, with the crisis rapidly turning into a battle of wills between Ankara and global financial markets. The beleaguered Turkish lira is already down about 40 per cent since the start of the year.

Relations between the EU and Turkey are already strained after more than 13 years of talks about Ankara's bid to join the Brussels-based bloc have stalled.

It doesn't help that Erdogan regularly uses Europe – and notably Germany – as a punching bag in his often overheated political rhetoric. All of it complicates any European political action to deal with the crisis in Turkey.

"Stab in the back"

Erdogan has claimed that foreign forces are behind Turkey's economic woes.

He has described as "a stab in the back" the tariffs imposed by US President Donald Trump on Turkish imports, part of Washington's bid to secure the release of a US pastor under house arrest in Turkey on suspicion of espionage.

The Turkish leader has also hit back by calling for a boycott on US electrical products and imposing tariffs on US imports such as cars and tobacco.

However, the result of the escalating US trade conflict has been to ramp up market concerns about the problems facing Ankara triggered by a ballooning deficit, a growing debt and runaway inflation.

Instead of rhetoric and confrontation, analysts have warned that Monday's moves by the Turkish central bank to boost liquidity in the nation's economy fall short of what is needed to address the country’s currency crisis.

But Ankara has rejected analysts' calls for Turkey to hike interest rates to shore up the lira and to seek International Monetary Fund assistance to help stabilize the nation so as to head off the risk of the nation plunging into a recession.

"Recent financial developments in Turkey are an expression of a crisis of confidence," said the head of Germany's influential Federation of German Industry (BDI), Joachim Lang.

Close ties

"The Turkish economy is suffering from a weak currency, high inflation and increasing foreign debt," the BDI chief said. "If financial stability is not restored, it would threaten to result in a recession."

Underlining the risks to Germany by the economic upheaval under way in Turkey, total trade between Germany and Turkey currently represents about 1.6 per cent of Germany's total trading volumes.

About 6,500 German-linked companies are active in Turkey, employing about 120,000 people after investing 10 billion euros (11.3 billion dollars) in the nation.

Germany is also Turkey's key trading partner, with nearly 10 per cent of the nation's exports shipped to Europe's biggest economy in 2017.