External vulnerab l t es

Turkey’s recent d plomat c spat w th the US – and the subsequent sell-off n f nanc al markets – has refocused attent on on the economy’s external vulnerab l t es. We have two areas of concern: the ncreas ng rel ance of Turk sh banks on wholesale fund ng and the recent r se n the share of the current account def c t (CAD) be ng f nanced by portfol o nflows. Both expose Turkey’s economy to a sudden r se n nvestor r sk avers on. The f rst s Turkey’s CAD and the dependence on fl ghty portfol o nflows to f nance th s. Although Turkey’s current account shortfall has narrowed n recent years, t s st ll – at around 4% of GDP – one of the largest n the emerg ng world. Just as mportantly, the defcts ncreas ngly be ng f nanced by portfol o nvestment nto Turkey’s equ ty and bond market. The key po nt s that portfol o flows tend to be vulnerable to a qu ck reversal f nvestor sent ment sours. D rect nvestment flows, wh ch are generally qu te stable, are very low Turkey – account ng for around 15-20% of total net cap tal flows. The second element s that the bank ng sector s ncreas ngly rel ant on fore gn wholesale markets to fund lend ng. As a result, the bank ng sector’s loan-to-depos t rat o has r sen sharply and banks have become more vulnerable to a l qu d ty squeeze. We are not suggest ng that the spat w th the US w ll cause these vulnerab l t es to crystall se and tr gger s gn f cant macroeconom c problems. But t does h ghl ght the Turk sh economy’s relat vely precar ous pos t on, espec ally compared w th other emerg ng markets. That’s why our GDP growth forecasts, of 2.5% n 2018 and 2.8% n 2019, are well below the consensus.

(Oct. 11)