Turkish central bank governor Murat Cetinkaya on February 14 voiced the possibility of easing liquidity, making comments that coincided with the release of worse-than-expected industrial production data for December.
Cetinkaya, asked about the national lender’s financial stability plans by state-run news agency Anadolu, responded: “A sound functioning of the financial system is key to the effectiveness of monetary policy… Accordingly, the Central Bank employs its liquidity and reserve requirement tools when needed…
“In view of cyclical conditions, liquidity steps can be taken to support financial stability. These tools and associated steps do not give a direct signal with respect to the monetary policy stance. It would be more appropriate to evaluate liquidity-related practices within the context of financial transmission. Our stance on monetary policy is clear; the tight stance will be maintained until we observe a significant improvement in inflation dynamics.”
The central bank was late to intervene when the Turkish lira currency crisis took a heavy toll on Turkey last summer. It finally came up with a significant policy rate hike in September coupled with significant liquidity measures. However, the regulator’s late-but-heavy moves to control the currency and, as a result, inflation, triggered liquidity trouble in the real sector. The banking system is now burdened by debt restructurings and booming non-performing loans (NPLs).
Stomach for a rate cut
Equity investors have already signalled that they could stomach a rate cut to overcome a worse-than-expected GDP growth print. As Charles Robertson of Renaissance Capital said on February 8 in an emailed note to investors: “To keep the currency this competitive, the Central Bank of Turkey (CBT) might need to cut interest rates as early as March. We think this could be justified by 4Q18 GDP printing -6% YoY against consensus expectations of around -2%. But we are arguing internally about that rate-cut possibility.”
However, bond investors are quick to remind those quailing at the severe sudden stop in real sector that it can be describe as “economic rebalancing”. No pain, no gain, as they might say. But how much is too much?
Cetinkaya’s comments on liquidity and reserve requirement steps that could be taken point to the central bank planning to please everyone by keeping real rates at double the level of the emerging markets universe while also easing liquidity conditions to help the real sector.
Easing liquidity could cause more FX demand among locals as confidence in the Erdogan administration remains low and reactive populism continues. However it should be noted that official figures would continue to support the theme of battling inflation while the central bank would keep the lid on lira depreciation via the Borsa Istanbul derivatives market and the Treasury would keep depressing domestic bond rates by cutting back on its domestic borrowing. Local lenders are, meanwhile, being "encouraged" by officials to cut deposit and lending rates. "Pressing down" on official and market indicators obviously generates significant risks of damming up an accumulation of negative energy. Pity the poor souls on whom it might burst.
Decline in industrial output escalates
Turkey’s calendar-adjusted industrial production index contracted for a fourth consecutive month in December and at the escalated pace of 9.8% y/y, data from national statistics office TUIK showed on February 14.
“The bigger-than-expected fall in Turkish industrial production in December adds to the evidence that the economy performed terribly in the final quarter of last year. We think that GDP may have contracted by as much as 4.0% y/y in Q4,” Jason Tuvey of Capital Economics said in a research note entitled “Turkey Industrial Production & Current Account (Dec.) - Further evidence of a terrible Q4”.
“The year-on-year contraction in GDP is likely to intensify in the first half of 2019”, he added. Capital Economics remains comfortable with its view that GDP will contract by 2.5% over the year as a whole. Its forecast lies below the consensus.
“Even with some positive contribution from tourism and other services sectors (such as financial services and public services), we are likely to witness a GDP contraction in 4Q in excess of 4.0% (or probably close to 5.0%), which is worse than earlier market expectations of 2.0-2.5%,” Serkan Gonencler of Seker Invest said in a research note.
“We maintain our view that the recovery in economic activity could start as of 2Q19 and bring the whole year GDP growth rate to 1% in 2019,” BBVA Research said in a note.
“Industrial production continued on a downward path in December, contracting -1.4% month-on-month, the fifth negative reading in a row,” Muhammet Mercan of ING Bank observed in a note to investors.
Broad global slowdown another concern
Rising fears of a broad global slowdown also remain a significant concern for Turkey when it comes to officials’ hope that the domestic slowdown can be balanced out with foreign demand.
“The slowdown in growth in the emerging world this year is likely to be unusually broad-based. That will set a downbeat mood for EM assets over the course of this year,” William Jackson of Capital Economics said on February 13 in a research note entitled “EMs facing synchronised downturn”.
“GDP data for Central and Eastern Europe showed that growth in the region held up pretty well at the end of last year—especially considering the ongoing weakness in Germany. Even so, growth still weakened everywhere, and today’s data probably mark the start of a slowdown across CEE,” Liam Carson of Capital Economics said on February 14 in a research note.
February 14 also saw the posting of a Turkish current account deficit of $1.44bn in December. Resulting from the partial recovery of the lira, it was the first deficit seen in the current account after four straight months of surpluses, the central bank noted.
“Still a great number. Rebalancing theme continues,” Tim Ash of Bluebay Asset Management said in an emailed comment to investors.
The current account deficit sharply declined by 42% y/y to $27.6bn in 2018, the lowest level seen since the 2009 crisis. In 2017, it stood at $47.3bn. The financial account experienced a 2018 outflow of $3.98bn versus an inflow of $38.5bn in 2017.
The deficits in the current and financial accounts were financed by unidentified inflows and central bank reserves. Inflows recorded under net errors & omissions reached a record $21.1bn last year, while the central bank reserves declined by $10.4bn.
Unidentified capital inflows via the net errors and omissions item in the balance of payments have under the rule of President Recep Tayyip Erdogan generally tended to rise during times when Turkey has faced external financing problems.
Net portfolio inflows sharply declined to $164mn in 2018 from $24bn in 2017 while net inflows into debt securities fell to $1.1bn from $21bn. Net portfolio outflows from Turkish equities amounted to $908mn last year versus a $3bn inflow in 2017.
Net FDI in Turkey rose to $13.2bn in 2018 from $11.5bn in 2017.
Turks’ net portfolio investments abroad rose to $3.18bn last year versus the minus-$394mn figure recorded the previous year while their FDIs rose to $3.64bn from $2.7bn.
“Other investments recorded a net outflow of 10.5 billion USD in 2018. This was mainly driven by banks’ credit repayments of 6.3 billion USD in the short term and 8.7 billion USD in the long term,” Isbank Research said in a note.
“[The banking] sector recorded a 66% rollover rate in December up from 8% in September while the figure for 2018 was 76%,” Mercan said in a separate research note.
“The corporate sector LT debt rollover ratio in December was at 73.4% in December though in annual terms it remained just below 100%,” Ozlem Bayrak Goksen of Tacirler Invest said in a research note.
Tacirler Invest expects the current account deficit to narrow to $16.7bn, or 2.3% of GDP, in 2019.
“Deleveraging in the private sector (especially banks) keeps on… This deleveraging process also helps explain the ongoing growth slowdown. The constraints in external funding also make a V-shaped recovery less likely going forward,” Gonencler said in a separate note.
“Despite some potential revival in intermediate goods imports (to sustain export strength) in a few months, as we expect domestic demand weakness to persist throughout 1H19, C/A deficit is likely to continue shrinking over the next few months, dipping at USD2-3bn (or possibly reaching a small surplus) by July 2019. The downward trend is likely to reverse in 2H19, but would only bring end-2019 C/A deficit to about USD11-12bn (1.8% of GDP) or probably slightly higher,” he added.
If the oil price turns out flat, Renaissance Capital thinks Turkey’s 12-month current account deficit will shrink to $1bn in July. Net portfolio inflows could amount to $10bn in 2019, and FDI might remain at around $7-8bn, it added.