Turkey now turns to Central Bank’s coffers
Deputy Prime Minister Nurettin Canikli said that the government was making arrangements to establish a new instrument for financial markets – so-called “bank bonds” – during a speech he made the previous week at the Banks Association of Turkey.
Banks will be able to issue bank bonds in return for loans they make. This will create funds and transfer the risk onto others. So far, this is nothing new. Banks have been issuing asset-backed securities by demonstrating their loan revenue for years.
What is new is the Central Bank will be able to use bank bonds as a liquidity instrument. These transactions mean banks’ credit risk will be offloaded onto the Central Bank. On top of that, it means the Central Bank, despite its statements that it pursues a “tight monetary policy against inflation,” will be pumping money into the market and igniting inflation. This is highly risky for the economy.
So, why would the political administration need such a risky measure? The answer is simple: Other routes are becoming congested or are already so.
The growth model based on portfolio inflows has long been constricted. While the growth rate declines, both unemployment and inflation are rising.
Now, there is a struggle to create vitality through public investments and expenditures. But that ruins the budget. The graph shows the size and pace of this destruction. The Treasury’s cash deficit for 12 months began to skyrocket just as the constitutional referendum became a central issue.
The cash deficit, which was 17.2 billion lira at the end of 2015, more than doubled in 2016 to 38.2 billion lira. Even scarier is the cash deficit has soared by 65 percent in the first four months of 2017 and now stands at 62.9 billion lira, which is above the levels seen during the global financial crisis of 2009 and 2009. In accordance, the net borrowing of the Treasury is also rising at a fast pace.
As a result, supporting growth with the budget is also difficult. Furthermore, the budget balance is the main draw for hot money, so a deterioration there may restrict such inflows even further and result in economic asphyxia.
There is a similar congestion on the loan front. The volume of banks’ loans is 15 percent higher than their deposits and other funds. Banks can only lend more than their deposits through foreign borrowing. Global fund flows are in reverse, and Turkey’s increased risk due to a weaker exchange rate has thwarted this front too.
The ratio between loans and deposits has stagnated since 2015. Banks have little chance of increasing credit volumes through foreign borrowing. On the contrary, conditions are forcing them to do just the opposite.
Meanwhile, the rate of bad loans is rising in parallel to the stagnation of the economy, increasing burdens on the credit system. Measures like restructuring loans and the government’s expansion of the Credit Guarantee Fund are down to these issues. However, the Central Bank cannot support the credit expansion for a long period. Despite the announcement of so many stimulus packages, stagnation continues. Unemployment and inflation remain high.
Meanwhile, Turkey faces three critical elections in the next two years. The political administration, which has run out of ammo in the budget and with banks, is now trying to desperately claw into the safe of the Central Bank.
We know very well what happens when you dip too far into the Central Bank from the 1999 and 2001 financial crises in Turkey. And we remember that those two crises had severe consequences on the political front.