At the start of June Turkey posted its best Manufacturing Purchasing Managers' Index (PMI) level since December 2013, moving from April’s 51.7 to May’s 53.5. The data showing a substantial uptick in manufacturing sentiment added to optimism that the economy could be on a gentle recovery path.

But the key question is whether or not the new growth fired by credit expansion will lead to economic advancement sustainable for at least a few years, rather than merely a run of quarters.

The upturn is apparently very much down to the Credit Guarantee Fund (CGF), under which the government has since last December made a massive TRY250bn (€63bn) available in loans, primarily to small and medium-sized enterprises.

President Recep Tayyip Erdogan – after seizing unprecedented powers in the April referendum on an executive presidency and governing by decree under the indefinite state of emergency – needs a strong economy to achieve a sweeping victory in the general election due in 2019. He will most probably use a combination of conventional or unconventional economic instruments to secure support for a decisive victory, forsaking the advice of more orthodox economists. Note his regular depiction of himself as an “enemy of high interest rates” and calls for cheaper bank lending.

The 1.3% y/y slump in Q3 GDP recorded last year followed the attempted coup and commencement of massive purges against individuals in both the public and private sectors allegedly linked to the “Gulenist conspiracy” to overthrow Erdogan. There was then a Q4 recovery in which GDP expanded at 3.5%, but the impact of the CGF should really be tangible in the Q1 economic growth figures when they appear on June 12. In advance of that data, however, analysts generally agree that the revival in economic activity evidenced by measures such as the PMI and economic confidence, which is at an 18-month high, is due to the credit impulse triggered by the CGF facility.

“Corporate loans have displayed a significant rise, particularly after the second half of March 2017 when corporate loans backed by the loan guarantees provided by the CGF accelerated,” the central bank acknowledged on May 30 in the latest issue of its Financial Stability Report.

As of May 28, TRY 160bn of loans had been extended by banks under the CGF to more than 270,000 businesses at an average interest rate of 14.4%, BusinessHT reported on May 30.  Of the loans, 75% was provided by private banks and 22.7% by state-owned banks. Some 90% of loan recipients were small and medium-sized companies.

The Institute of International Finance (IIF) suggested in a research note on Turkey published on May 4 that the credit impulse secured by the CGF pushes up real GDP growth with a lag of one or two quarters. Total lending by Turkish banks, which remain very profitable, increased by 23% y/y to TRY1.86bn in January-April, the latest data from the banking industry BDDK watchdog showed.

Taking into account the strong loan expansion registered over the first third of this year, the Turkish economy should thus post positive growth rates at least for the first and second quarters of 2017.

 “It seems that a very sizeable credit impulse is now feeding into an economy that bounced back reasonably well from the disruption last year, suggesting that real GDP growth will likely come in, perhaps substantially so, above consensus,” the IIF concluded.

The country’s central bank shares this optimism. “Downside risks related to economic activity have significantly decreased owing to the incentives and supportive measures taken,” it said in the Financial Stability Report.

Not risk-free

While the loan books of the banks expanded, the banking industry’s NPL/total loans ratio very slightly edged down to 3.31% at the end of April from 3.32% a month earlier. But in the SME loans segment, the picture is a little different. The NPL/total loans ratio in this segment had steadily increased to close to 5% as of March 2017 from below 3.5% at the end of 2014, according to data in the Financial Stability Report. For larger firms, the ratio declined by around 2.5% at the end of 2014 to around 2% at end-March.

Local media have reported other problems too. With the loans to deposits ratio in the industry hitting a record high of 125%, banks have, reportedly, engaged in a race to attract funds by offering high interest rates on deposits. The loan to TRY deposits ratio stood at 140% in May, according to central bank data. The average interest rate paid on one-month deposits offered by local banks has risen by 43 basis points in two weeks to 13.1%, BusinessHT reported on May 26.

Moreover, local newspapers have cited cases of wasteful and unproductive use of loans. Some loan takers have parked money they received under the CGF scheme in deposits accounts, while other business owners have used loans to buy luxury cars or property.

The IIF pointed to the fact that the CGF scheme allows banks “to transform part of their corporate loans into government-guarantee assets with no capital requirement”.

UBS analysts wrote in a May report that investors were questioning whether the recent loan growth implied a relaxation of underwriting standards, and if CGF loans were simply delaying the recognition of asset quality problems in the SME segment, with the unguaranteed portion of CGF loans (lending is guaranteed for up to 80% of each individual credit) creating further asset quality problems further down the road. UBS expects loan growth to normalise in the second half of this year “given the system's funding constrains.”

The government also has plans to help banks overcome their funding problems by allowing them to securitise loans. Under new legislation, banks will be able to package and securitise their assets in any format – as a loan or a package of loans – and turn them into cash, Deputy Prime Minister Nurettin Canikli said on May 5.

Turkey’s largest listed lender, Is Bank, has pointed to a potential danger here. Analysts at the bank noted a recent media report suggesting that the authorities were working on a plan where banks would be able to place their loans under the CGF scheme as collateral and get short-term liquidity from the central bank. “Such news has been previously denied by government officials but the stretched loan to deposit ratios of the system also call for an immediate measure so there is an ability to maintain the loan growth. If that happens, banks will likely benefit and the TL [Turkish lira] deposit cost run may lose steam; however it may create pressure on the Turkish lira,” Is Bank said in a report published on May 29.

Most analysts agree that the loan growth will have a positive impact on banks’ profits. But there also sceptics who raise questions over the true prospects for growth.

For instance, according to the IIF, the government guaranteed scheme has encouraged banks to restructure some of their existing – and often nonperforming – loans, pushing them into the CGF programme. “Such portfolio shifting provides little support to economic activity but it should give support to bank profits in 2017,” it said.

But the central bank says it is confident the recovery trend will reach a higher pace in 2017 with accommodative macroprudential policies, fiscal policy and credit incentives to be implemented.

It also claims to see other side-benefits of the loan expansion. The national lender argues that since credit growth is mainly driven by the rise in corporate loans, it mitigates the negative impact of the recovery in domestic demand on the current account deficit.

It remains to be seen how all of this will play out. The government is anxious to put the economy on a growth track for the short and medium term via more credit and other measures aimed at boosting demand, but investors want Ankara to carry out long-delayed structural reforms seen as key to sustainable economic growth over the longer term.