Δευτέρα, 9 Ιανουαρίου 2017

The lira and Turkey’s risky debt

by Robert Veldhuizen
2016 was a difficult year for Turkey. The country faced multiple political and economic problems, ranging from a failed coup in June to long-standing structural economic problems. In the coming year, Turkey is likely to face problems in the same areas it did in 2016 – volitile growth rates, high-levels of international debt, and political fights over monetary policy.
Growing concerns
At the close of 2016, Turkey’s economy contracted by 1.8% per Q3 GDP figures, while the Turkish lira has lost more than a fifth of its value since September. This devaluation is attributed to mounting political risks following the attempted military coup, as well as increased interest rates and US dollar buoyed by the prospects of an expansionist fiscal policy under Trump.

Following the attempted coup, Erdoğan has secured reforms to centralize and potentially extend his power until 2029. The subsequent crackdown has purged thousands of military personnel, academics and businesses, resulting in condemnation and failing accession talks with the European Union.

The resultant security void and Turkey’s increased presence in Syria has resulted in intense fighting against ISIS and PKK militants. This in turn has intensified instability in the country’s southeast and led to increased attacks within Turkey’s cities— such as the recent bombing outside Istanbul’s Besiktas football stadium and the assassination of a Russian ambassador in Ankara.


Such incidents have already adversely impacted Turkey’s tourism industry, which contracted by as much as 40% in the summer of 2016. Worsening conditions are likely to continue into 2017, which could strain Turkey’s fragile regional and domestic stability.
A dependency on debt
Erdoğan’s Justice and Development Party (AKP) oversaw the rapid expansion of the Turkish economy between 2002 and 2007, when GDP expanded an average 6.7% annually. However, due to the 2008 global financial crisis, Turkey’s GDP shrunk by 4.5%. Although the AKP managed to increase growth in 2010 and 2011, this recovery was unstable at best, because it was built upon a massive influx of foreign capital from developed economies undergoing policies of quantitative easing.

This availability of this sort of near zero-interest capital is fleeting at best — it comes in when times are good, and flees once they turn bad. Without this enormous influx of foreign investment, Turkey would not have averaged 3.3% growth between 2012 and 2016. With global interest rates on the rise due to an expected expansionist fiscal policy imposed in the US, Turkey and other emerging markets who relied heavily on this sort of capital will have a high price to pay.

Much of Turkey’s borrowing has been done in US dollars. A rise in the dollar’s value will substantially hurt Turkey’s ability to service its debt, which in the worst-case could drastically sever the flow of foreign capital it relies on for economic growth. While Turkey’s Central Bank has had some success in reducing its deficit, the same cannot be said for its private nonbank sector which owes close to $210bn in foreign currency liabilities. Thus, the economic recovery made possible from this unchecked credit boom became not only a massive dependency, but also a huge debt vulnerability to the Turkish economy.

Furthermore, pervasive structural issues such as Turkey’s high rate of unemployment and inflation, low-rate of savings amongst its domestic population, dependency on energy imports, increasingly volatile growth trajectory, and banks low profitability will continue to leave the country at the whim of international currency markets. It is consequently far from sure that Turkey will be able to maintain the 3.5% GDP growth it needs to finance its debt.

The IMF forecasts that in 2017 Turkey’s current-account deficit will rise from 4.4% to 5.6%, with real GDP growth declining from 3.3% in 2016 to 3% in 2017. Furthermore, $95bn of Turkey’s $430bn debt is expected to rollover within the next 12 months.

Political risks of the lira
Investors in emerging markets are more likely to tolerate a country’s poor economic and financial fundamentals when the country’s political environment is stable. However, once the chance of such an environment sours, investors are likely to look elsewhere. This is currently happening in Turkey due to the country’s political and economic risks.

The absence of unity and direction amongst Turkey’s economic leadership over the country’s monetary policy has done little to ease the worries of investors. The lira’s recent devaluation has put Erdoğan and the central bank increasingly at odds over how to best handle the situation. While this debate has endured over the years, the stakes are now arguably at their highest.

The lira’s recent slump prompted Erdoğan to call on Turkish citizens and businesses to stockpile lira and gold in order to halt the “economic sabotage” carried out by the country’s enemies, as well as break the “tyranny of the dollar”.  Resisting the demands of Erdoğan, the Central Bank responded by raising interest rates for the first time in over three years.

A self-proclaimed “enemy” of high interest, Erdoğan wants the Central Bank to reduce borrowing costs, viewing high interest as a tool used by foreign powers to keep the Turkish economy weak. He sees low interest as a necessity to spur waning growth, a policy largely focused on appeasing the general populace. While Erdoğan has proclaimed his respect for the bank’s autonomy, he has gone as far as to brand proponents of high interest as “traitors”.

The Central Bank and its supporters argue that increased interest rates are a necessity to stabilize the Turkey’s volatile currency and increasing inflation. While such a ‘correction’ is likely to negatively impact growth—potentially causing a recession—supporters argue that it is a less harmful option than letting the lira depreciate even further. This sort of depreciation would wreak major chaos on corporate and government balance sheets.

If the government and the central bank continue to be divided over policy they will certainly further weaken the country’s sovereign credit profile. Troubled loans have so far risen to their highest in seven year, with foreign-currency lending making up a third of total loans. Ratings agency Fitch has therefore revised its outlook for the country’s banking sectors in 2017 from “stable” to “negative”.

By the close of 2016, investors responded to Turkey’s tumultuous environment by renewing foreign financing at their lowest levels since 2013, with almost every Turkish bank seeing a decline in participating lenders.

Looking ahead
Turkey will seek to implement necessary reform to its finance and banking sectors in 2017 to weather increasingly unfavourable global economic conditions to emerging markets. The country’s need to keep interest rates down to attract foreign capital, will come into conflict with the realities of rising domestic inflation and its depreciating currency. Erdogan’s populist strategy of using low interest rates to promote growth will only intensify this conflict.

While GDP is forecasted to average around 3.8% between 2016 and 2020, it is just 0.3% above the rate required to service its foreign currency liabilities. The economy therefore teeters dangerously close on the cliffs of recession. Many observers will be looking at the upcoming constitutional amendment vote as well the government’s tumultuous relationship with the Central Bank.

Little imagination is required when hypothesizing dire forecasts in the wake of any further economic or political crises—particularly when the AKP’s success rests on continuous economic success.

Amidst Turkey’s poor economic and security environment, the 2016 saw the drastic reversal of Turkey’s previously deteriorating relations with Russia — with sanctions placed on Turkey following the downing of a Russian jet in November 2015. Both countries now find each other as increasingly-essential strategic allies within region, with neither side wanting the normalization of such relations derailed, even in the wake of the recent assassination of a Russian ambassador in Ankara.

Recent developments have seen Turkey broker a ceasefire agreement with Russia over Syria, as well as attempt to shore up the lira through negotiations to possibly use it in the country’s energy trade with Russia, Iran and China. Such maneuvers may underline the growing unreliability of Turkey as a dependable ally to Western interests within the region, and may indicate a strategic repositioning away from the West.

Looking ahead towards 2017, Turkey finds itself increasingly at the crossroads on how to best balance its short and long-term political and economic futures and how to weigh their often-incompatible considerations. This delicate balancing game by Erdoğan incurs significant security, political and economic risks to an already fragile Turkish state. Many eyes will be on Turkey this year, with foreign leaders, policy makers, businesses and investors monitoring developments in-country over the coming months.


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