Economic forecasters see dark clouds gathering over Turkey, and they’re not at all sure they can be dispersed. Analysts are getting the jitters. The Istanbul stock exchange, until recently a big draw that registered a series of all-time highs, was — taking the ISE30 index which in euro terms fell 9% m/m in September — the worst performing major emerging market bourse last month. And there are growing signs that the government-backstopped lending boom could end in tears.
William Jackson, senior emerging markets economist for Capital Economics, tells bne IntelliNews: “I agree that there’s a problem of over-lending. We’ve warned about the build-up of vulnerabilities in the banking sector for some time. The rise in the private sector credit-to-GDP ratio over the past decade has been larger in Turkey than in any other emerging market, except China. Usually, credit expansions on this scale result in a misallocation of resources and problems further down the line. I think the scale of these problems is not yet appreciated by the markets.”
Gauging what might come next, Jackson also reflects: “The big improvement in the economy has probably now happened. Private sector credit extension has slowed and we suspect that GDP growth has peaked in Q3, and will slow in Q4.”
Timothy Ash, senior sovereign strategist at BlueBay Asset Management — who, to a fair degree, sprang to the defence of Turkey in mid-September when Commerzbank put out a report questioning the country’s official growth figures and suggesting that its economic “miracle” was not actually happening — said in a note to investors on 28 September that “Turkey is becoming quite a challenging story/market to read”, adding: “Quite a few negatives are building up.”
Ash observes: “Particularly worrying in my mind is that the quality of financing has deteriorated this year, with 70% of the CAD [current account deficit] now covered from ‘hot money’ portfolio inflows, and a smaller share (25-30%) from net FDI and longer-term investment flows. Errors and omissions have turned negative, perhaps reflective of capital flight, and the CBRT [Central Bank of Turkey] has been spending limited FX reserves to help support the currency.”
Turkey’s underlying and longstanding weak external financing position, with the official CAD standing at $39bn, or 4.6% of GDP, and widening despite a competitive currency (the real effective exchange rate has been back at 2003 levels), is also a concern to Ash. Add in the weight of the $165bn short-term debt, and the external financing requirement comes in at more than $200bn, or 25% of GDP, for 2017.
Nervous locals forego cheap lira
Another conundrum pointed out by Ash is that “while foreigners have been on the bid for lira for much of the period since the April referendum on constitutional reform [to introduce an executive presidency with sweeping powers], attracted by the high carry/volume, and still liquid global financing conditions, locals have persistently remained on the other side, as reflected in the constant accumulation of FX deposits, now at/close to record highs.”
This, remarks Ash, “is unusual in the Turkish context, as I cannot remember a time when the locals have forgone opportunities from a cheap lira and carry for this long — faced with a strong foreign bid they have always eventually tended to throw the towel in. What this seems to reflect is an underlying concern from a section of the population over broader political trends (polarisation) in the country, and perhaps nervousness over the extended state of emergency [in place since July last year]. I guess logically the constant purges against Gulenists, and those associated therein (rightly/wrongly), creates nervousness and a natural desire to sit on FX.”
Clearly, concludes Ash, the combination of a weak underlying external financing position, plus reliance on hot money foreign financing, and also the strong and continued local bid for FX, “leaves the market vulnerable say to a change in global sentiment, if/as the Fed tightens, as the combination of locals and foreigners selling would then be all powerful”.
Bears feeling chipper
Getting back to the Istanbul bourse - the September decline of which was the first monthly reversal since November 2016 - somebody’s pain is as always somebody else’s gain. The bears are feeling chipper, with short traders piling into bets on the rally crumbling.
“Turkey has started to underperform and once it starts, it goes pretty fast,” Maarten-Jan Bakkum, a senior strategist at NN Investment Partners, told Bloomberg on 24 September, adding: “It is going well for me for a few weeks.”
Once again, the wisdom of the government’s triggering of an explosion of credit growth via the introduction late last year of its TRY250bn ($69.98bn) credit guarantee fund (CGF) — now almost exhausted — is in question. The CGF has backstopped lending to SMEs, helping to push Turkey’s economy to growth of 5.2% in the first quarter and 5.1% in the second quarter and to buttress a rally that added $90bn to equity values.
But is a wheel going to come off? In the eyes of some analysts, the stock market now lies exposed to bouts of profit-taking. The CGF pushed the country’s loan-to-deposit ratio to a record high and, as Charles Robertson, the London-based global chief economist at Renaissance Capital, advised investors in early September: “The companies that shouldn’t borrow have started to borrow as well. We’ll see these companies failing to pay debt and the government intervening.”
Throw in Kurdistan and a stymied Merkel
Adding to geopolitical woes that increase the risk of Turkey being thrown off course is the Kurdistan Regional Government’s referendum in northern Iraq which to Ankara’s great annoyance has undoubtedly stirred up greater passion among Kurds in Turkey who dream of their own homeland. There is some prospect of Turkish trade blockades against the KRG causing wider difficulties in exporting to Iraq, thus aggravating Turkey’s balance of payment difficulties. What’s more, should the government maintain its refusal to accept any KRG-sanctioned oil sent by pipeline, it may have to find more expensive replacement crude that will add to its annual energy import bill of $35bn or more — a figure almost equal to the CAD, notes Ash, who also reminds investors that traditionally each $10 a barrel hike in oil prices costs Turkey $4bn in its current account spend.
A further drag on those contending Turkey’s robust economic performance so far this year boasts plenty more stamina to come, was the German election result which failed to produce the expected convincing win for Chancellor Angela Merkel. “The hope had been that with a strong win, Merkel’s personal ‘chemistry’ with Erdogan would be put to work to ease Turko-German and EU tensions, and benefits on the EU trade/investment front. However, with likely longrunning coalition talks, and the prospect of weak elections, it seems unlikely that tensions between Germany and Turkey, as well as the EU will ease back any time soon,” says Ash, adding: “Indeed, the strong showing of the AfD and parties of the extremes in Germany likely will put the focus back on the logic/benefits (or otherwise) of the broader EU enlargement process.”
With inflation still surprising on the upside, remaining more than double the central bank’s target at 11.2.% and, in terms of core inflation, reaching a 13-year high — “ultimately a reflection of years of unorthodox and ultimately inappropriately loose monetary policy, dating back to at least 2011,” says Ash — it’s not hard to make the case that, at the very least, overcast skies could settle over Turkey. But the economists do have plenty of counterbalancing positives to reach for. Ash rattles off a great range of plusses including the remarkable durability of Turkish growth this year that shows an underlying dynamism, “a reflection of well-known credit strengths—strong banks, sound public finances and space for fiscal loosening which has been used to good effect, favourable demographics and a pro-business culture”.
Anti-market rhetoric abates
In wrapping up his analysis he adds: “There has been something of a return to some form of economic/business orthodoxy from the Erdogan administration since the referendum. I think there is recognition there that the early AKP success was based on generating inclusive growth and job creation (600,000 to 700,000 a year) on the back of a pro-business reform agenda. And certainly since April, ministers and Erdogan have tried keeping to the script of the need to focus on business, investment, jobs and growth — ‘it’s the economy stupid’. Anti-market rhetoric has abated a bit, albeit Erdogan and ministers still cannot help themselves occasionally kicking banks for not cutting interest rates on loans quickly enough.”
The political situation, concludes Ash, along with the central bank’s track record means it is unlikely to pre-emptively move on rates by tightening, which suggests that the lira might have to take the strain. An alternative way forward, he suggests, would be for the government to create some domestic feel good factor and “therein the most obvious choice would be lifting the state of emergency, to buoy domestic confidence and stem local capital flight.”
“This could work,” he says, “but given last year’s [attempted] coup, problems on the Kurdish/KRG front, and Erdogan’s own insecurity within the AKP — see the resignation [last week] of the mayor of Istanbul — I doubt that Erdogan would sign off on this as yet, more likely keeping [the state of emergency] in the run-up to the 2019 elections as at least it seems to have stabilised the domestic security situation which is helping tourism to recover”.
Alas, not even the recovering tourism data can keep the critics at bay where Turkey is concerned right now. Cracks in that data are readily apparent. The revival is very much based on Russian visitors arriving in droves, encouraged by Moscow’s rapprochement this year with Ankara since the late 2015 clashes over Syria policy and the shooting down of a Russian fighter-bomber. But the European tourists who deliver the big bucks still prefer other destinations for their holidays such as the Western Mediterranean. Year-on-year tourist arrivals have risen for five months in a row, but the total number of German and UK visitors was down 30% in the January to August period compared to 2015.
Indeed, adding to the new fashion for knocking Turkey, this week’s collapse of the UK’s fifth biggest airline, chartered and scheduled carrier Monarch, was very much laid at the country’s door by the operator’s CEO. The root cause of the airline going out of business was seen as terrorism in Egypt and Tunisia, as well as the collapse of the market in Turkey, brought on by both a wave of terrorist attacks and the country’s disturbing political division and strife. Not a good advert for a supposedly recovering tourism market or for Turkey’s prospects more generally.