COMMENT: Turkey surprises

By bne IntelliNews March 23, 2010

Timothy Ash of The Royal Bank of Scotland -

Turkey's performance through the global crisis that preceded and followed the fall of Lehman Brothers has been surprising.

Its large budget deficit (about $100bn) and external financing requirement as of late 2008, with a current account deficit of around 6% of GDP, and memories of recent crises, eg. 2000-01, led many to believe that it would be leading the pack in the region in seeking emergency funding from the International Monetary Fund (IMF). As has proven to be the case, Turkey managed to ride through the crisis, funding itself under its own resources without going cap in hand to the IMF. Remarkably, this set Turkey out from a bevy of existing EU member states (Latvia, Hungary and Romania) that were forced to agree emergency stand-by arrangements with the IMF.

Explanations for Turkey's durability through the crisis are varied. Policymakers would no doubt highlight that reforms instigated after the 2000-2001 crisis stood the economy in good stead. Over the period since, Turkey's fiscal stance has been prudent, with the public sector debt/GDP ratio cut from over 90% in 2001, to less than 40% in 2008, ie. well below the Maastricht convergence criteria for the euro, and around half the EU average.

Turkey's banking sector was significantly "cleansed" following the 2000/01 crisis - bank balance sheets were cleaned up, while regulation and supervision were much improved. Turkey's bank deposit base proved resilient through the crisis; perhaps helped herein by the parallel weakness in global banks - if Turks were going to take their money out of Turkish banks, where would they put their cash? US or West European banks at the height of the crisis appeared close to failure. Importantly, Turkey's banks were relatively slow in following the trend in emerging Europe of expanding rapidly into consumer, household and mortgage credits. Its banks thus had little subprime exposure.

Banks and corporates did have large net open foreign exchange positions at the onset of the crisis. However, and unlike Russia, these were not generally publicly held and hence not as subject to mark-to-market risk. A large weight of Turkey's private sector external liabilities also tended to consist of offshore lending back into Turkey, and when push came to shove, these were generally rolled over. Turkey also benefitted from the fact that the stock of forex deposits at the start of the crisis was close to record highs (about $100bn), partly due to heightened political tensions in 2007-2008 over the headscarf issue and then the closure case brought against the ruling AK Party. Locals tended to sell dollars into extreme lira weakness, which provided an underpinning to the exchange rate. Similarly, due to perceived political risks, foreign portfolio investors had generally reduced exposure to Turkey in 2007 and early 2008, and hence technically the market was not as vulnerable to hot money outflows. The exchange rate adjustment which occurred in late 2008 - the benefit of the floating exchange rate regime - helped close the external financing gap, with the current account deficit falling by some two-thirds in 2009 to around 2% of GDP, helped also by reduced oil and commodity import prices.

Real disappointment

And yet while Turkey successfully funded itself through the crisis, the price was a disappointing performance from the real economy, which probably contracted by around 5.5% for the full year in 2009. This was more or less on a par with its regional peers, but disappointing compared to Poland, also a large relatively closed economy (in terms of trade turnover/GDP), which grew by 1.7% in 2009.

Understanding why the real economy underperformed in 2009 is important, as it should offer an insight into the likely future performance. Herein, we would partly explain this underperformance by Turkey's export profile, which tends to be in higher end, final consumption products, eg. autos, white goods, TVs and higher-end textiles - ie. exactly the product mix in low demand in key markets in Europe, and indeed in the former Soviet Union.

A further explanation of Turkey's relatively deep recession probably lies in the fact that the economy had already begun to slow down well before the demise of Lehman, with real GDP growth of just 1.1% for the full year in 2008. We explain this slowing by rising concern domestically over political risks, which undermined consumer and business confidence. The slowdown in 2008, however, left Turkish companies sitting on high inventory levels in mid-2008, and then the economy was hit by the double whammy after the fall of Lehman, which saw a brutal inventory correction. The low base from 2008 and then 2009 does create some room for a bounce in 2010. Exports are showing some signs of recovery from a low base, albeit given the expectation of weak recovery in Europe more generally, it is a tough ask to assume that this will be the key driver for growth over a slightly extended forecast period. Domestic demand, meanwhile, looks set to be subdued by continued political noise in the run-up to the 2011 parliamentary elections, ie. the ongoing fissures over the Ergenekon case and plans for constitutional reform.

This still suggests a weak recovery, after an initial bounce in early 2010. The weak domestic - and indeed global - growth environment should, though, eventually weigh inflation down, which has been pushed back into double digits over the first few months of 2010 by one-off factors, eg. administered price increases. We expect inflation to subside to year-end and into 2011, and this should still enable the central bank to hold to its lower-for-longer interest rate strategy.

Timothy Ash is Head of Emerging Markets Research for The Royal Bank of Scotland

COMMENT: Turkey surprises

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