It’s a marathon
Hectic days are over, at least for now. Why? The black sheep of emerging markets, like Argentina, Turkey and Russia, all agreed to increased rates to stabilize markets and stem rising inflation. In defending their currencies, emerging market central banks need to choose between early gradual action and late emergency hikes. The Central Bank of Turkey (CBRT) hiked 625 basis points to stabilize the lira, while the Central Bank of Russia (CBR) hiked by 25 basis points to support the ruble. Market participants, especially emerging market-focused investors, welcomed the decisions with jubilation over the containment of crisis before reaching developed markets. However, it’s not that simple, and the issues are still in places which may precipitate a textbook crisis of emerging markets.
As you might follow the developments in Turkey through news outlets, the increasing interest rate provided a relief rally in the markets and somewhat brought back confidence to markets. High policy rates do not come without costs to the domestic credit-dependent economy, whilst the decision does not necessarily signal any expectation of the broader macroeconomic policy framework.
President Recep Tayyip Erdogan’s decision to take direct control of the sovereign wealth fund on September 12 and his September 13 ban on the use of foreign ex- change for all domestic contracts point to a strategy of administrative controls.
Emerging markets-focused economists argued that such a strategy is ultimately likely to prove ineffective in dealing with Turkey’s underlying problem of foreign-currency funded credit expansion and its burden on the domestic banking sector. According to a Moody’s Investors Service report published on August 31, in the next 12 months, around $77 billion of foreign currency wholesale bonds and syndicated loans, or 41 percent of the total market funding, needs to be refinanced. The real issue is the companies’ reliance on debt and their ability to service that debt. This may result in a series of corporate defaults which may hit the banking sector at large.
I remember the earlier days of Kemal Dervis’s service in the cabinet. As you might remember also, the former World Bank executive was hailed by the markets for his strict macroeconomic plan and his attitude to support the corporate world. The result was restructuring corporate debts in a legal framework (named the Istanbul Approach) of non-performing, problem loans. Issued in April 2002, the plan resulted in the restructuring of more than $7 billion of corporate debts in just a fouryear period.
While the Central Bank of Turkey has started with a bold move on rates, the upcoming Medium Term Program will be decisive in the macroeconomic future of Turkey. Maybe a plan on restructuring loans besides the details of macro figures, fiscal consolidation roadmap and perhaps a fiscal rule will be important.