Turkey has been in perilous financial market straits for going on two years now and it’s becoming hard to draw attention to just how worrying the situation is. Well, let’s try… Holy smoke! Net portfolio flows to Turkey remained below zero for 14 consecutive weeks from December 20 to March 27, with the total volume amounting to $6.72bn, according to the latest data from the Turkish central bank.

The same period saw $4.63mn flow out of domestic government bonds, bringing the non-residents’ share in the securities to 6.8% as of March 27 from 7% the previous week and the more than 10% recorded at  the end of January.

The central bank has been buying up domestic government bonds at an “unprecedented speed” with its purchases amounting to a record high of Turkish lira (TRY) 9.3bn ($1.37bn) last week, Reuters reported on April 6.

Non-residents still held $10bn worth of domestic government paper along with $22bn worth of equities as of March 27. They also still owned 55%, or $45bn, of sovereign eurobonds and 80%, or $40bn, of corporate eurobonds.

The Q1 outflows of around $62bn from emerging markets were roughly twice the size of outflows recorded at the peak of the 2008 global financial crisis, the Institute of International Finance (IIF) said on April 2 in a note entitled “COVID-19 Capital Flow Exodus from EM”.       

March saw a record-breaking $83.3bn in portfolio outflows from emerging markets, the IIF added on April 1 in a note entitled “The COVID-19 Cliff”.

The bad news for Turkey and its peers is that markets may be starting to refocus on the coronavirus (COVID-19) growth hit to emerging markets, which—even after the unprecedented Q1 outflows—could start a second wave of outflows, it added.

Stimulus outstripped EM peers

Stimulus provided by the Turkish central bank has far outstripped that of its EM peers over the past year. The national lender’s has blazed a trail, slashing its policy rate all the way to 9.75% from the 24% seen last July, with combined cuts of 1,425bp in just nine months.

Markets see another rate cut, this time of 100bp, as in the pocket when it comes to the rate-setters’ meeting scheduled for April 20, while the central bank has even been pumping liquidity into the system at lower cost than its benchmark. The weighted average cost of its funding fell to 9.19% on April 3.

An interesting form of quantitative easing (QE) was, meanwhile, introduced when the central bank announced last week that it was donating TRY100mn to President Recep Tayyip Erdogan’s campaign to raise funds to help those in need amid the pandemic.

Turkey’s gross FX reserves fell to $64bn as of March 27 from $65bn the previous week and $77bn at end-February. The net reserves, excluding gold and swaps, have remained below zero since the end of February.

“Turkey spent $40bn in 2019 propping up the lira to contain inflation and has blown another $20bn 2020 ytd. State banks blasted their way through another $1.5-2bn yesterday to undergird its currency but you simply cannot buck the mkt forever,” Julian Rimmer of Investec said on April 2 in a note to investors.

The central bank increased the limits on lira-to-forex swaps by banks to 30% of their foreign exchange market transactions from the previous 20%, Reuters reported on April 3.

The amendment will bring about an increase of around $5bn in lira-to-forex transactions, according to two unnamed bankers.

FX deposits held at local lenders fell to $228bn as of March 27 from $233bn as of March 6, emerging as a new source of real FX demand.

“Financial alchemy”

“All the market focus is on the GIR [gross international reserves], NIR [net international reserves] and FX deposit data to see the decline in reserves and whether FX reserves are still staying in the system, to continue to facilitate the CBRT’s [Central Bank of the Republic of Turkey’s] financial alchemy of taking FX reserves from one pocket to put in another to defend the lira, and allow them still to run a very loose monetary policy,” Timothy Ash of Bluebay Asset Management said on April 2 in a note to investors.

“In the end the CBRT does not have enough reserves to sustain the current strategy that long. Question now in my mind is could they boost reserves from alternative sources? The IMF would be the obvious source, but Erdogan seems to have half burned that bridge... as he seems unprepared to take the political hit, while not wanting IMF oversight and conditionality. An alternative might be friendly central banks—thinking Fed, ECB, maybe even Qatar again. Erdogan mentioned as much in the G20 session last month,” he added.

As of April 6, there was no sign of an IMF or Fed swap deal ahead of a telephone conversation due to take place between Erdogan and Donald Trump.

A White House statement later simply said the two leaders agreed to work closely together on the international campaign to defeat the pandemic and bolster the global economy.

What’s the plan?

All observers continue to wonder what the Erdogan administration is planning as regards Turkey’s indispensable FX needs as the central bank continues to sell cheap dollars that end up in portfolio outflows. Will it act before all FX in the country has gone!?

The Fed opened a swap facility for foreign central banks that pays out in exchange for US Treasury paper, but Turkey only had $2.8bn of such paper as of January, down from $77bn in 2014 and $53bn in 2017.

“Turkey’s IMF deal in particular would surely dwarf Argentina’s record $57bn bailout… A deal for Turkey could amount to around three quarters of the IMF’s total outstanding country loans… It’s also possible that the US vetoes any potential deal for Turkey given their turbulent political relationship,” Edward Glossop of Capital Economics said on April 2 in a note entitled “Three key questions on IMF support for EMs”.

“To be clear, domestic politics mean that policymakers in those countries are likely to exhaust all other options (capital controls, import compression and bilateral loans) first before turning to the Fund. IMF help will be a last resort. One thing to watch for in the coming weeks will be the incoming FX reserve figures. If these begin to slide, it would be a worrying sign that external vulnerabilities are biting,” he added.

“In the face of rapid capital outflows, EMs may turn to capital controls to stabilise balance of payments positions. Such measures might help to stave off crises in some countries (particularly if they come alongside external support), but strains in the balance of payments would remain severe,” Nikhil Sanghani of Capital Economics said on March 31 in a note entitled “Would capital controls work in EMs?”.

The Turkish Finance Ministry on April 4 authorised staff abroad to develop relations with public or private fund providers.

“Rewriting the rulebook”

“The road ahead is unusually uncertain. What we can be sure of at this stage is that the slump in output over the coming months will be huge,” Neil Shearing of Capital Economics said on March 30 in a note entitled “The coronavirus is rewriting the economic rulebook”.

The rolling over of Turkey’s more than $150bn worth of FX debt with maturities of up to one year is progressing without defaults.

“It is unlikely that, even with very benign assumptions (such as global interest rates remaining close to zero for an extended period), debt can be assessed to be sustainable for many countries where financing needs will be large,” JPMorgan analysts including Nora Szentivanyi wrote in an analysis as quoted by Bloomberg in a story entitled “The Same Stimulus That Rich Countries Lean On Could Worsen Poor Economies”.

In March, Turkey’s trade deficit jumped to $5.28bn from $2.17bn a year ago, according to the latest data from the trade ministry.

Exports plunged by 18% y/y but imports were up 2% y/y despite the cost of oil imports falling to $2.66bn from $3.71bn a year ago.

There was a 22% y/y rise in capital goods imports to $2.48bn and a 13% y/y increase in consumption goods imports to $1.85bn in March.

Intermediate goods exports were down 2% y/y to $14bn in the month.

The story of the collapse in oil prices since March provided Ankara with the required reasoning to legitimise the official inflation and current account data, but the realities will be clearer when the April foreign trade data arrives at the beginning of May.

“It’s possible that some governments may start to view inflation as a way of reducing the burden of debt accumulated as a result of the current crisis,” Shearing said on April 6 in comments under the title “How to think about the inflationary consequences of COVID-19”.

Given the virus emergency, Turkey’s revenues of service exports such as tourism or air transportation will fall to zero in April. Capital and consumption goods imports will also fall sharply while intermediate goods exports should also decline as most industries have halted production. Oil imports are also set to decrease in April on falling demand.

Governing perceptions

It is worrying that the tourism minister talks of plans to send local tourists to vacation facilities at the end of May and expects foreign tourists to arrive in June. Those who want to offer up surreal and utopian vistas are entitled to do so, but for a Turkish minister to resort to such talk just shows that he’s part of a government that is not really capable of governing the country, rather it seeks to govern perceptions.

Some stories to explain why Turkey’s GDP growth has not collapsed in the official data will also no doubt be planted, but the only buyers will be some mainstream analysts, not investors.

Well let’s end on one positive. The hygiene and personal health products market in Turkey has seen a boom in demand and is projected to triple in growth by year-end, Daily Sabah reported on April 3. Can Turkey still come up smelling of roses?
 

Non-residents' holdings of equity and government domestic debt securities ($ mn) (Market Value)
	2017	2018	2019	Mar 27
STOCK
Equity	51,984	29,563	32,422	22,290
GDDS	30,942	18,325	15,448	9,756
Repo	2,403	314	573	456
Private	959	612	406	344
NET TRANSACTIONS (Adjusted for Foreign Exchange and Market Price Effects)
Equity	3,191	-904	409	-2,064
GDDS	7,278	-906	-3,146	-4,332
Repo	271	-1,391	269	-17
Private	42	-343	-231	-37
source: tcmb