What to do with Turkish political economics?

about economic success, PEOPLE TALK management skills, and good economic policies as if political economics were merely a technical issue. Yes, it is technical in some respects but its essence is politically economic, therefore social. Yet we are accustomed to enumerate which policies proved correct and what others were erroneous. A policy mix can be correct or wrong, but according to what metric? If closely following and implementing the IMF-Derviş programme of 2001 is posed as the unique measure of success, then AKP did succeed at that time. Had the government not followed the programme that was readily available in 2003, there could have been major problems early on. Possibly snap elections would have been held either in 2004 or 2005. Yes, this can be deemed a “success” but that’s all there is.

THE SEA̞CHANGE

The first period between 2003 and 2006 changed the way foreign investors viewed Turkish assets. Especially, banks attracted attention and many large overseas banks bought the shares, even majority stakes, of Turkish banks. European credit markets were saturated so overseas operations became crucial for major banks. Think of BVVA and the LATAM operations after 2008. In Turkey, consumer lending was very weak at that time but in 2004 and 2005 housing and car loans skyrocketed. There was the infamous “global savings glut” so dollars poured in. People talked about becoming a 1 trillion dollar economy, and that was considered an important goal. The Lira over-appreciated because Turkey easily attracted foreign capital of all sorts. There was talk about 1 TL = 1 USD being the new equilibrium in the exchange rate market. True, exporters complained and the current account deficit soared, but these were two inevitable by-products in a sense. Homes were sold because an instrument remotely resembling mortgage was issued, and luxury cars were imported because the Lira was valuable and imports were quite cheap. The dream of buying a Mercedes was suddenly within reach for shopkeepers, merchants and SME bosses in small Anatolian towns.

THE SEEDS OF DISTRESS

Was that all? Was it so easy to become rich? You hit the wall, the IMF steps in, and there a stabilization programme is designed –sort of a rescue package. Basically you keep a tight budget for a couple of years. And you become rich! Too good to be true, isn’t it? But the Lira appreciation had this kind of side effect, a wealth effect so to speak. Starting early on, when inflation fell to single-digits in 2004 and the Lira appreciated even in nominal terms, corporates began to borrow in FX-denominated terms. They had FX deposits on the asset side, and FX deposits recorded losses as the Lira appreciated. So, it was logical to balance that by dollarizing the liability side. The world was washed with dollars, and tapping international corporate debt markets was less costly than borrowing in TL terms. Hence, all financial multiples doubled up in a short span of time, the change rate risk disappeared while nominal and real TL interest rates continued to drop down. Voilà, you got yet another source of affluence. Because the exchange rate isn’t the main determinant of international competitiveness, despite constantly voiced complaints exports increased although perhaps margins were lower. Those who claimed that the programme was predicated upon a continual inflow of “hot money” and that all public assets were being hastily and unduly privatized were presented as “dismal scientists”. They were leftists who couldn’t understand how markets worked. The prediction that the soaring current account deficit would eventually create a balance of payments crisis or an exchange rate risk was cast aside as pessimistic. Those criticisms weren’t perhaps correct verbatim, but they contained more than a grain of truth. The very success of the IMF programme had already sown the seeds of distress, especially for Turkish agriculture. At about that time AKP was discovering the two pillars of growth, real estate and energy, and went to the limit of what those two sectors could offer.

SHORT̞RUN VS. LONG̞RUN

Doomsayers proved correct in 2008, but from a market viewpoint pointing to risks a few years back didn’t mean anything. You can always make profits. Roubini had said in 2005 that there was catastrophe ahead but it happened after three years, and people continued to do business in the meantime. The Turkish economy was at the cross-roads in 2013 before Bernanke spoke signalled that the Fed would raise rates on May 22, 2013. After that any “success” was only temporary both because it was among the Fragile Five after the stressful summer and because the domestic growth model was stuck. Even so financial analysts weren’t entirely wrong when they were bullish after 2004 because it took 8-9 years before the inherent weaknesses became visible to the untutored eye. There are similar examples. For instance, the US stock market was exuberant between 1995 and 2000, and the bubble that was formed did only burst after five years. Now, bubbles can be rational and it may take years before they burst. American nominal assets gained value in the 1990s and even

the simple fact that the borrowing cost decreased by 200 basis points in a decade can explain equity multiple enhancements. Interest rates fell but a lot of money poured in and the US stock markets soared.

A TECHNICAL DIGRESSION

People also wonder why stock prices go up against a backdrop of stagnating economic activity, or at best meagre earnings growth and weak industrial corporate momentum. Consider a line of argument that gives much food for thought. Investment and valuations display positive co-movement. Bubbles may emerge even when the current interest exceeds the rate of growth of the economy and the corporate sector generates a surplus. And while it is still the case that the emergence of a bubble crowds out resources for investment, the speculative growth dynamics guarantees that investment still booms along the path. By the same token, if the speculative growth path crashes, then no longer the conditions exist for a rational bubble to survive and it must crash as well. Finally, a bubble that emerges early on in a speculative path is costly because it crowds out potentially welfare-improving capital accumulation and because it overexposes the economy to a crash. Conventional rational bubbles exhibit positive co-movement with investment and arise even when all investors and savers face high interest rates. If the growth-saving feedback is sufficiently strong, the economy exhibits multiple steady states. Since the marginal product of capital is decreasing in the stock of capital, the speculative steady state exhibits a lower cost of capital than the normal steady state. Since the valuation of an asset is simply its price divided by earnings, and in steady state the former is just earnings divided by the cost of capital, valuation is equal to 1/the cost of capital. Thus, the speculative equilibrium is equivalent to the high valuation equilibrium. How can the economy have a low cost of capital in the speculative equilibrium when it requires more saving to be sustained? Precisely because higher capital raises saving enough to more than offset the reduction in saving due to the decline in interest rate resulting from lower marginal product of capital –supply of funding shifts more than demand for funding.

THE TURKISH CASE

A remarkably similar story can be told about Turkey. After 2002 the Lira appreciated even in nominal terms. This is what made the AKP administration look successful. Starting in 2004, corporates began to over-borrow in dollar terms. The plenty of global dollars has had a bearing and borrowing dollars in London at low cost was easy for all EMs. The growth rate was higher than before because foreign capital helped boost it. The average growth between 2002 and 2006 was 7.2%, an above trend performance. In the 1990s (1990-2001) that figure stood at 3.4%. As the IMF-Derviş programme neared its end, problems began to surface. To sum up, the first 3-4 years after the 2001 economic debacle things went well. Between 2008 and 2018 the management has only tried to mitigate the harmful effects of overseas capital coming and going. After that nobody could understand what was going on, except perhaps that a speedy plan of wealth transfer was put on stage. In January 2018 the exchange rate was 3.77 against the USD. Today it stands at 19.35. The CAGR of depreciation is 38.7%. That same metric was only 5.66% between 2003 and 2018. After 2018 all anchors have been lost.