High-risk economics
Turkey edges closer to crisis
Turkey is facing a fullblown balance of payments crisis as foreign funds flee the country and the plummeting lira cripples companies saddled with dollar debt. The financial debacle comes as the US imposes sanctions on two Turkish ministers in an escalating political clash, demanding the release of an American pastor detained on espionage charges.
The lira crashed to an all-time low of 5.09 against the US dollar yesterday. It has fallen 35pc since mid-february, rivalling Argentina as the poster-child of the emerging market storm of 2018.
“This could get a lot worse. Turkish corporates have borrowed in dollars and euros and they are not hedged,” said Robin Brooks, chief economist for the Institute of International Finance (IIF), the world’s leading watchdog on emerging markets.
The slide in the Turkish lira is turning dangerous for a country with foreign currency debt worth 60pc of GDP and a current account deficit of 6.1pc that requires constant inflows of capital. “They need to stabilise the exchange rate right now,” said Tim Ash from Bluebay Asset Management. “The central bank should have raised rates in June. It was an absolute no-brainer, and it is beyond comprehension why it was not willing to do so,” he said.
Turkey has become reliant on short-term debt to keep afloat as foreign direct investment in factories and the real economy dries up.
It has built up $180bn (£138bn) of foreign loans on maturities of less than one year.
Gross financing needs over the next 12 months have ballooned to $230bn. This creates acute “roll-over risk” at a time when the US Federal Reserve is raising interest rates and draining global dollar liquidity.
The fast-moving events in Turkey are a foretaste of what can happen when the tightening cycle exposes weak links in the vast nexus of offshore dollar lending. The Bank for International Settlements estimates that emerging markets have borrowed over $7 trillion in US currency, including equivalent derivatives. The volumes are unprecedented and have yet to be fully tested.
“We think Turkey and Argentina are the harbingers of a broader trend,” said Brooks.
“We have flagged South Africa, Indonesia, Colombia. There has been crowding in exotic places like Lebanon and Egypt as investors search for yield. It is classic ‘late-cycle’ behaviour.”
The G3 giants – the Fed, the Bank of Japan and European Central Bank – are all tightening. “This raises the risk of a synchronised bond sell-off and that is very bad for emerging markets,” he said.
What concerns the IIF is that the global interest rate shock so far has been modest. Yields on 10-year treasuries have risen just 60 basis points, yet the damage has already been as great as in the “taper tantrum” of 2013 when the moves were much greater. It is a warning sign of how vulnerable the tired, over-leveraged system has become.
Turkey has brought matters to a head early by flouting economic codes. The government’s credibility is in tatters after pumping up artificial growth in a pre-electoral boom and pressuring the central bank to hold down rates. President Recep Tayyip Erdogan excoriates the “interest rate lobby” for anti-islamic usury.
Investors fear that the regime is becoming more authoritarian, erratic and capricious. Finance minister Mehmet Simsek – a former Merrill Lynch banker educated in London – was fired in July. He was replaced by Erdogan’s son-in-law.
Ash said it was not too late to avert disaster, provided the country takes its bitter medicine and restores orthodoxy. “It is a balance of payments crisis but it is not yet a banking crisis like 2001. They have very well-respected blue chip companies with close links to Western banks. They still have their destiny in their own hands,” he said.
Standard & Poor’s said Turkey’s current account deficit is the third largest in the world in absolute terms, and “usable” foreign reserves cover just 1.4 months of cross-border payments, a wafer-thin security buffer. “Should capital outflows accelerate further, it would increasingly question Turkey’s ability to finance its large deficit,” the agency concluded in May.
S&P said dependency on foreign debt leaves the country at the mercy of currency swings. “The lira’s continued weakening poses a major risk to banks’ capital levels and asset quality,” it said.
Lenders lack a sufficient base of lira deposit funding, forcing them to rely on the foreign currency swap markets to the tune of 25pc of GDP.
The ratio of bad loans in the banking system has risen to double digits, if measured properly. “We are increasingly seeing signs of distress,
‘They need to stabilise the exchange rate right now. The central bank should have raised rates in June’
‘The lira’s continued weakening poses a major risk to banks’ capital levels and asset quality’
such as some larger Turkish corporate holdings approaching creditors about restructuring their loans. We think these trends could accelerate,” it said. The mix of high leverage and lira devaluation is proving toxic.
S&P warned that any move by the US treasury to broaden sanctions to Turkish state banks or entities could cause the crisis to crystallise. This is now in clear focus.
There is already a dispute over past violations of the Iranian oil embargo, an issue that is coming to a head again as Erdogan vows to flout Donald Trump’s renewed curbs on Iran. The quarrel over the American pastor, Andrew Brunson, has raised tensions to fever pitch. He is accused of helping the exiled cleric Fethullah Gulen in an alleged coup in 2016, but Washington retorts that he is being held unjustly as a bargaining chip.
The US move to sanction Turkish ministers is an extraordinary act by one Nato member against another. It heightens fears that the military alliance is close to crumbling.
Erdogan’s decision to choose to buy S-400 surface-to-air missiles from Russia and to form a “strongman” bond with Vladimir Putin has been seen as a slap in the face at Nato headquarters.
The Turkish foreign ministry warned that the country would retaliate against Washington. “Without delay, there will be a response to this aggressive attitude,” it said. The lira instantly fell further.