The current consensus suggests that the Turkish lira is not expected to depreciate this year as much as it did in 2018 when it sank into a currency crisis. The main supporting argument for this contention is the recovery in Turkey’s current account deficit. However, when the bigger picture is examined it is not possible to conclude with any real certainty that the currency will retain relative strength.
This time last year, prominent economic research institutions, including Capital Economics and the International Institute of Finance (IIF), sounded warnings about currency vulnerabilities seen in Turkey and Argentina.
However, Capital Economics reiterated a view on April 16, in its latest EM Financial Risk Monitor for Q2, that “the risks of similar currency crises [to those that eventuated in 2018] occurring now is low”.
It added: “No major EM has a current account deficit on the same scale as Turkey and Argentina did a year ago. And following falls last year, EM currencies look more fairly valued. Admittedly, the Turkish lira and Argentine peso are not out of the woods—indeed they’ve been the worst performing EM currencies this year. While both countries’ current account deficits have narrowed, gross external financing requirements are still high on account of both countries’ large amounts of short-term external debt. That said, their currencies are less vulnerable to the falls of the order of 30% seen last year.”
The IFF’s views are more or less similar to those of Capital Economics on these points, with its fair value for the USD/TRY rate remaining affixed to 5.50.
Pole position for banking vulnerabilities
Meanwhile, Turkey has retained pole position for banking sector vulnerabilities in Capital Economics’ EM Risk Monitor. “Banking sectors in the emerging world are generally in a healthy position. But there are lingering problems in Turkey’s banks… Turkey’s banks have suffered a rise in non-performing loans resulting from the economic downturn. This has been exacerbated by the sharp increase in credit in the preceding decade (a large share of which is denominated in FX). Moreover, the country’s banks are very dependent on foreign wholesale financing. And rollover risks have increased following the recent tightening of external financing conditions,” Capital observed.
Also, Turkey’s sovereign vulnerabilities are moving closer to the red zone in Capital Economics’ Monitor.
The Turkish lira (TRY) lost around a third of its value against the USD during the course of last year with the USD/TRY rate finishing 2018 at 5.29 compared to the 3.79 recorded at end-2017. During the worst of the currency collapse in August it nosedived into the 7.20s—hitting an all-time low, as the row with the Trump administration over detained US Pastor Andrew Brunson deteriorated. Since last November, the Turkish central bank and public lenders have managed to put something of a brake on the lira—although the government in amateurish fashion has been setting crude horizontal barriers at the cost of burning through reserves. Its approach has been supported via external borrowing at terrible expense and has prompted nervous locals into buying FX, substantially adding to the strain on the lira.
Turkey’s overall external debt repayment obligations for the next 12-month period stood at $177.1bn at end-February, marking a distinctly limited $8.8bn retreat from the $185.9bn figure at end-February 2018, despite the economic collapse brought about by the currency crisis, central bank data showed on April 17.
The figure was previously seen at $173.9bn at end-October last year as a result of the ‘curing’ effect of the currency crunch, but since then it has once more trended upwards with the government having gone on a renewed external borrowing spree that was followed by private corporates, private banks and public lenders also issuing new debt from the beginning of 2019.
The debt was issued on pinkish as-much-as-fragile sentiment for emerging markets among international investors, which lasted until the week leading up to the March 31 local elections that became an unofficial referendum on President Recep Tayyip Erdogan.
When lenders’ and corporates’ obligations to their branches and affiliates abroad are excluded, Turkey was obliged to repay $156bn in foreign debts across the next 12 months as of end-February, up from $155.4bn as of end-January.
On April 15, central bank data on the private sector’s outstanding foreign loans showed that the sector was obliged to repay $62bn in external loans across the 12 months following end-February. This figure stood at $70.5bn at end-July 2018.
The Turkish private sector is on the hook to repay (as there is no news of defaults) $7bn in foreign loans this month and it is due to pay another $8.5bn in May. Recall that in May last year, when the lira was traded against the refrain of “Sell in May, Go on holiday!”, the currency started to break through its historical record lows against the USD.
Lost its window
Presently, the Turkish government appears to have lost its window for external borrowing given how it shot itself in the foot when it stunned financiers by starving the London swap market of lira last month in a bid to frustrate short sellers and protect the currency in election week. Last September, finance minister Berat Albayrak enjoyed rather fruitful meetings with hot money investors in London, but—partly given the swap market shenanigans—his latest encounter with such investors last week, when he arrived in Washington for the IMF and World Bank spring meetings, by many accounts proved one of the most sobering experiences a finance minister has ever endured. Sure, he returned back home with a photo of himself talking Turkey in the Oval Office, but the bad and scathing language used by investors in describing his on-stage presentation of a so-called economic reform package was enough to make even some of the tougher-talking traders blush.
Financiers funding the way ahead for the Erdogan administration were sold on the idea of officials taking a serious and focused approach to fixing Turkey’s economic ills once the country had moved beyond the local polls and into a four-year period in which there would be no scheduled elections to upset calculations (such remedial work is long overdue, the country’s economic difficulties have essentially been growing since 2011, though they were much disguised until half-way through last year). But the elections served up a humiliation for Erdogan and his AKP party, with the opposition scoring two heavily symbolic victories, those of Ankara and Istanbul.
The “will he, won’t he” question as to whether strongman Erdogan will attempt an Istanbul poll rerun to reassert his authority has now been bugging the markets for nearly three weeks, and, given Erdogan’s manoeuvres since election night, all those Pollyannas who insisted on seeing the political situation in Turkey as normal may finally take a long hard look at themselves. What’s more, it no longer seems viable that the governing coalition can avoid holding snap elections all the way up to 2023, given the perilous situation with the economy and the new currents running through domestic politics.
Since last week, indeed, there have been ominous rumbles from the IIF that Turkey could already be in the midst of another ‘sudden stop’ in its balance of payments. The first occurred last August after the lira tanked. Another occurrence could help rein back the current account deficit—which has lately started pulling away again—but it would be bad news for debt roll-overs.
Central bank data suggest that the market value of foreign investors’ overall Turkish equity stock on the Borsa Istanbul fell to $30.5bn as of April 5 from $49.4bn as of end-March 2018, while the picture is even more dramatic in government bonds—the market value of foreigners’ domestic government bonds stock fell to $14.5bn from $29.3bn and repo stock severely declined to only $307mn from $2.07bn.
The descent in equity prices and the currency depreciation unfortunately do not explain the dramatic decline in foreigners’ stock of Turkish securities as the more eye-popping decline in bonds is mainly due to the Treasury’s efforts in suppressing bond rates in evidence since November. They have spooked foreign investors. The government has in the meantime kept the ship upright by cranking up external borrowing, but with the channels for that now seemingly closed there is a big question mark as to what it plans next. Budget metrics and the borrowing requirement have also deteriorated further compared to last year as transfers from the central bank have already been spent and there are growing payment obligations to idle mega infrastructure projects.
The Erdogan administration can wave its Oval Office photo at external financiers as much as it wants, and it may well find some thick-skinned investors who’ll deal, but only at the cost of higher and higher interest payments that would anyway only delay the collapse, just as has been the case since last September. And more significantly when it comes to the question we posed at the start of this article, those thick-skinned investors would demand a stark currency devaluation that would pave the way for a retreat in the local currency at the point they entered into the market.
So what about the IMF? The IMF option brings some obvious questions. When would the deal be ready? Would the US give its approval for IMF support (there are numerous unresolved disagreements between Ankara and Washington that could at any moment lead to a Twitter bombardment during one of Donald Trump’s critical moments of reflection during “Executive Time” in his private quarters)? And would Erdogan, once oh-so-proud of delivering what he said would be Turkey’s final goodbye to the IMF, countenance having the Fund re-entering the equation?
FX deposits hit historical highs
Another difference from last year’s time ‘before the fall’ is the situation with domestic confidence. Local individuals’ FX deposits have hit historical highs in the $109bns across March and April. At end-March 2018, the figure stood at $96bn before gradually declining to as low as $87bn in August last year in parallel with the path taken by the USD/TRY rate. It has progressively grown again since then in line with the suppressed USD/TRY.
The government will need to employ a currency devaluation to make locals sell their FX, or dollarisation can only keep growing.
Meanwhile, the central bank’s net international reserves were given as $27.8bn as of April 5, down from $30.2bn as of end-March. Recent developments in the central bank reserves have fuelled suspicions among some market commentators who have started talking of a “cooking of the books”.
The hand of manipulation has also allegedly been seen messing about with inflation. It officially stands at slightly under 20% versus about half that in April last year. Looking at the growth figures, there are some who are not ready to accept that they are dependable while the real conditions that Turkish banks are grappling with are also a mystery. A question mark now also dangles over the sustainability of shrinking the current account gap as Turkish unemployment and impoverishment have reached alarming levels.
Then there’s that ever important sentiment abroad. Despite a dovish Fed, it is deteriorating once more. “Our Tracker suggests that overall EM capital outflows eased markedly in Q1. However, we think that positive sentiment towards EMs will start to turn over the coming quarters as worries about weak global GDP growth weigh on investor risk appetite, causing capital outflows to rise and currencies to fall,” Capital Economics said on April 17 in its EM Capital Flows Monitor.
All in all, there are desk calculations based on official data that can lead us to conclude that the lira is less vulnerable compared to last year. Yet, delve behind those data for some more telling figures and add in the disintegration evident in Turkish and international politics coupled with the polarisation and accelerating disintegration of Turkey on all fronts—it is hard to find real assurance that the lira is any less susceptible to a cave-in than it was in the spring of last year.