Acute economic restructuring in Turkey delivers record monthly current account surplus of $2.8bn

Acute economic restructuring in Turkey delivers record monthly current account surplus of $2.8bn
By Akin Nazli in Belgrade December 11, 2018

Turkey’s current account surplus for October has come in at a record monthly high of $2.77bn, the central bank announced on December 11.

That beat the forecast of a Reuters poll of economists that on December 7 anticipated an October surplus of $2.55bn. A Bloomberg survey predicted $2.5bn.

The October figure exceeds the record monthly surplus of $1.88bn that was achieved in August, following the collapse of the Turkish lira (TRY). The three-month cumulative surplus recorded for August to October amounts to $6.45bn.

“As a result, the annual current account deficit has eased to USD39.4bn (4.9% of GDP) from the previous month’s USD46bn (5.8% of GDP),” Ozlem Bayraktar Goksen of Tacirler Invest said in a research note, adding: “For November, the foreign trade figures released by the Trade Ministry have also implied a surplus at around USD0.7bn. All of these factors pose downward risks to our recently revised CAD [current account deficit] towards USD30bn from USD33bn”.

“We might see the C/A deficit edging further to USD26-27bn in December. If the pace of the past few months is maintained, it would not be surprising to see the C/A deficit below USD20bn (actually close to USD15bn) in 1Q. This downward trend in the C/A deficit might continue to support TRY stabilization [all other things being constant],” Serkan Gonencler of Seker Invest said in a research note.

“In August, with $/TRY above 7.00, we were among the first to talk about Turkey's current account turning to surplus & supporting the Lira. On a trend basis, it has gone from -$70 bn (annualized) to +30 bn, but since this is mostly cyclical our fair value for $/TRY is still 5.50,” Robin Brooks of the International Institute of Finance (IIF) said on December 11 on Twitter.

The Reuters poll of economists and Turkish finance minister Berat Albayrak also expect the end-year current account deficit to fall below $30bn.

The 12-month cumulative deficit stood as high as $58.1bn in May, when 2018’s first currency shock was observed, and it has followed a declining path since then.

“The pace of the amelioration in the CAD has been much better than our estimates, which also imply the negative course of the economic activity,” Goksen also said.

“Really staggering”
“Rebalancing anyone? Really staggering the extent of domestic deflation and the ‘shrink to fit’ now of the CAD—but the price will be recession. Will be interesting to see how the [central bank] reacts on Dec[ember] 13 at its next rate setting meeting—cannot see a cut there as the lira remains fragile,” Timothy Ash of Bluebay Asset Management said in an emailed comment to investors.

“We are tracking Turkey's current account in surplus at this point. Compared to other EMs that have seen similar ‘sudden stops’, this isn't unusual. The median current account (black) in large devaluations goes from -3% to +2% of GDP. Turkey is tracking right in line with that,” Brooks said on December 6 in a tweet, adding in another one: “2018 was eventful for EM. 2019 will be about the fall-out. Big question for Turkey is how deep the contraction will be. Median peak-to-trough contraction in similar ‘sudden stops’ is 10% (black). Our annual average forecast of -0.9% in 2019 only anticipates -5%, so downside risk.”

Bullish sentiment
The Turkish lira market has been dominated by bullish sentiment of late and global commentary on the state of the Turkish economy has turned far rosier, partly due to a big PR push from the Erdogan administration. However, the Turkish economy has only just weathered a severe currency shock and there is now a very tough battle ahead to overcome a harsh sudden halt in much economic activity caused by severe credit and confidence crunches.

The markets like what they see in the record current account surpluses as a result of shrunken growth given the strong desire for rebalancing. November’s surprisingly strong slowdown in inflation to only 21.62% y/y is perceived as a clear and positive result of Ankara shifting back to orthodox economic policies, but there are potentially black clouds on the economy with the government tempted to relax fiscal policy to ease the pain being felt by Turkish voters ahead of the local elections scheduled for March 31 next year. The electorate must be wondering what happened to the warp-speed growth, which even in the first quarter of this year was clocked at 7.4% y/y. The central bank, meanwhile, may also feel some pre-election pressure for loosening. The GDP growth figure of just 1.6% y/y for the third quarter announced on December 10 points to the economic stress industry and consumers are by now feeling.

Question mark over US relations
Another question mark continues to hang above relations with the US. It was the worsening of the multi-faceted rift with Washington that brought the worst of this year’s currency crisis. Relations have been somewhat mended of late, but there are plenty of unresolved issues and with the unpredictable Donald Trump at the helm of the White House, there is no way of saying whether Turkey will continue to get a boost from soothed relations with America. The likely global headwinds next year from the course taken by the world’s key big economies can also not be gauged satisfactorily at this point, especially with so many fickle issues, such as the US-China trade dispute.

The rapid improvement in Turkey's external balances continued in October thanks to increased price competitiveness which supported exports, weaker domestic demand due to deteriorating confidence, and a significant financial tightening, Muhammet Mercan of ING Bank said in a research note. He added that the capital flow outlook, on the other hand, remained challenging with a continuation of outflows at $1.4bn.

“Capital outflows in October were mainly attributable to a further increase in residents’ asset holdings abroad, at $2.3 billion (mainly due to a $1.0 billion rise in trade credits extended and a $0.8 billion increase in deposit holdings), while portfolio flows, which have followed a weak trend since early 2018, turned slightly positive at $0.8 billion thanks to the Treasury’s $2.0 billion Eurobond issuance.

“On the borrowing side, banks were payers with $1.4 billion ($1.0 billion of which was for short-term obligations). However, the monthly (long-term) rollover ratio for the sector increased to 91%, the highest since May, showing improving access to foreign funding after recent volatility. On a 12-month rolling basis, long-term rollover ratios for banks and corporates stood at 89% and 138%, respectively,” Mercan explained.

“How will a debt payer extend credit to someone else?”
Turkish banks made $10.8bn worth of net loan repayments in January-October, Hakan Ozyildiz, a former Treasury official, said on Twitter. He asked: “How will a debt payer extend credit to someone else? This will be the development that will determine the future of an economy which grows with debt.”

“For the January-October period, there is a USD6.4bn capital outflow compared to the USD39.8bn inflow of the same period of last year. This YoY deterioration is mostly attributable to portfolio investments; last year’s USD25.3bn inflow turned to a USD3.2bn outflow this year. Specifically, there are respective USD1.4bn and USD0.8bn outflows from equities and local currency bonds this year, vs. respective USD3.1bn and USD7.6bn inflows last year. The banking and corporate sector issued net USD8.4bn of Eurobonds last year (of which USD7.2bn belongs to banks), while this year redeeming a net USD1.4bn. Taking loans and Eurobond issuances together, we note that there has been a USD5.7bn reduction in private sector debt this year so far, vs. a USD11.7bn increase in net debt last year. This deleveraging process also explains the ongoing growth slowdown,” Gonencler also said.

As per the capital movements front in October, inflows, though at lesser amounts, from net direct investment ($699mn), net portfolio investments ($491mn) and net errors and omissions ($355mn) were the sources that were of help, according to Goksen.

Challenge of sizeable external financing needs
“The October data shows that outflows have further moderated compared to August and September, becoming less of a market concern. However, the outlook will likely remain challenging given the sizeable total external financing needs in the period ahead, mostly due to private debt amortisation. This will likely keep Turkey vulnerable to shifts in global risk appetite. On a positive note, the recovery in the trade balance will remain in place going forward given ongoing domestic demand conditions and the strength in exports, with the inclusion of tourism, though the pace of rebalancing will likely slow,” Mercan added.

Thanks to the surplus in the current account, official reserves recovered by $1.7bn in October, bringing the 10-month cumulative decline to $15.2bn across January-October while inflows observed in the net errors and omissions item amounted to $18.4bn across the first 10 months.

“Since the end of Q1 2018, the EM sell-off has hit foreign investor holdings in Argentina (ARS) the hardest, but even here actual outflows were modest. The same is true for Turkey (TRY), where much of the loss reflects valuation losses, not foreign investors heading for the exit,” Brooks said on December 6 in another tweet.