Pride and prejudice
As I claimed last week, a balance of payments crisis per se, i.e. old style, isn’t in the cards. However, an FX funding squeeze is a flat, open, crystal-clear reality and there is more to come. It isn’t only the current account deficit that matters. It is the stock-flow-debt service dynamics that count more. As such we are talking about at least $235 billion for the next 12 months, and funding is both scarce and expensive. FDI doesn’t even count as a serious source of funding. Portfolio flows don’t match financing requirements either. Hence, it is mainly banks securing overseas funding, bond issuances and FX-deposits held abroad repatriating. As a result, the CBRT net reserves have eroded. There isn’t ammunition enough to smooth the FX market, and I strongly believe TRY interest rate hikes have either already past the threshold of defending the currency or are very near to that point. As we know full well, the relationship between the local currency ex ante real rate of interest – a proxy for the ‘equilibrium rate of interest’ given inflation - and the exchange rate isn’t monotonic. Furthermore, it can be non-linear. The problem is in fact no longer the issue of stabilizing the currency via the interest rate. The problem is to convey a clear signal to the effect that the CBRT is no longer ‘behind the curve’. Inflation may not have peaked yet. Moreover, a second clear signal ought to come from the budget front. Obviously, these are only the necessary conditions. Political realignment and overall risk avoidance are also key. In short, a clear sign acknowledging that “yes, we are aware of the urgency of the situation” is warranted. I think we may be near to the moment of reconciliation with economic and international realities, only to face in autumn the new geopolitical challenges that lie ahead, i.e. Iran and all that. The sooner the better of course, given that solvency risk for some corporates have already surfaced.
Cost of debt r ses
What is risk? There are times risk – or in this case measurable uncertainty if we stick to the distinction of Frank Knight between risk and uncertainty - depends on a common factor. In 2004-2005, for instance, Brazil and Turkey performed similarly, their equities moving in almost complete daily correlation for 18 months. The fundamentals of those two countries were totally different though. At about the same time, other assets also performed hand-in-hand in the two countries. It looked like Turkey was one composite asset index and Brazil another, and the two composite indices also moved together. The common denominator was international flow of funds at a time when there was talk about a “global savings glut”. Today, Turkey looks more and more like one composite asset driven by a composite risk coefficient. It is the country risk. As the country risk has risen in an environment unfavorable to EM credit, the cost of corporate FX debt has risen to 175 bps above the benchmark interbank rate, and the amount of syndicated debt dropped by a hefty 26 percent in the first four months. Overseas funds have been pulling back. It isn’t only CDS, it isn’t only credit risk, but it is a composite risk phenomenon and can only be addressed at that level. The risk is not company-specific or idiosyncratic either. Turkey’s FX-denominated sovereign debt yield has jumped from 5.2 percent in January to 7.5 percent now. That is almost a 50 percent rise. The international net investment position had already deteriorated 5 years ago but had recovered since then. Now it is back to around 54 percent, a very high ratio as percentage of GDP. That ratio was only around 26 percent in 2008. Because most of it is floating, the burden increases as time goes by. At this stage of the game, I don’t look at ratios as much as I look at sheer numbers. Because the EM pie is shrinking, and because Turkey’s debt is large, ratios aren’t that interesting. The amount of funding required per annum is large and that is what matters most.
Inflat on hasn’t peaked yet
Inflation truly matters now, perhaps more than ever in the last decade or so. Because electoral studies reveal that people care much more about jobs and income, i.e. growth, than inflation ahead of whatever elections that loom on the horizon, governments tend to favor growth at the expense of inflation. Also, because inflation is only an index and various Gini groups may have different inflations depending on their spending patterns, whether the head-on CPI is 8 percent or 9 percent may not change approval ratings. However, when inflation climbs and nears ‘moderate inflation’, i.e. 1520 percent, there is a risk of an inflationary spiral to form up and you can face ‘runaway inflation’.
Moderate inflations are notorious for tipping off either way in a short span. Moderate inflation is like a flat yield curve, so to speak. Again, at around 16 percent, inflationary pressures are being felt by households, and cost-push inflation is still rampant. The 25 percent domestic producers’ price inflation 15.85 percent CPI ‘scissors’ isn’t a normal pattern. I think 17-18 percent CPI in Q4 wouldn’t surprise anyone. That has already had a clear impact on all sorts of loan rates. This is so much so that the ex ante real rate is over 8 percent now because inflation expectations are slow to adapt. The 5-years CDS and the 2- and 5-year TRY bond rates are moving up hand-inhand, and that says it all. The risk we are talking about right now is a composite risk or country risk, and it has all sorts of ingredients, from the market risk to credit risk to political risk to the risk of not having a plan. Still, it can be handled because it is measurable – for now. Beyond a threshold, risk metrics might acquire a dynamic of their own and as such transitional dynamics in the neighborhood of a strange attractor may mean something else. I still assume that the topology is Hausdorff, the vector space is finite-dimensional, and lack of market-clearing at infinity doesn’t obtain – yet. As long as the peak level of inflation is anticipated, and the risks remain measurable, we are within the confines of equilibrium economics as we know it in general.
Panem et c rcenses
Bread and circuses. This is what Paul Veyne reminded us decades ago in an unforgettable tour de force. Had the Credit Guarantee Fund not done the trick for 2017, we would have witnessed a similar ending a year ago, or so it seems. Alternatively, the EM rush of 2017 that lasted for 7 consecutive months could have done the trick. In fact, they both did. I toyed with the idea of a delayed disequi- librium to come half a year ago, but it didn’t work. Interestingly, the country risk parameters jumped after the February-March VIX volatility surge. One reason is because equity and bond risks didn’t move simultaneously, neither here nor there. The upshot is there is one election left, and the logic of panem et circenses warrants a degree of freedom where none exists. I repeat: risk is one and only now. Risk is holistic.
Not only has the modus operandi of the system changed but also the operational mode itself has been dramatically altered. There is no coming back. The olden values and the olden systematic working of the political system are no more. The polity itself has changed and so the voting behaviors and the strategic –or not - voting patterns of the people. It took a long while though, and still a good part of the people isn’t readily available to accept the new operating system without doubts and hesitations. Furthermore, economic voting – as a universal constant - still has bite. However, a built-in reactionary mechanism within the right-conservative wing had been firmly established from day one. Furthermore, over the years the conservative center-right developed historical reflexes to the effect that nationalism and religion weighed much more than liberalism. Liberalism has always been embedded in conservatism and the so-called center-right conservatism in turn was not distant from the nationalistic and religious tails of the critical mass. Being at the center, nonetheless, and being in a position to address the median voter electorally, may have truly helped conservatism to tame the radical ends of nationalism and Islamism. The center-right may have acted exactly as the opposite of a pencil sharpener as regards the tails, but there is a limit to everything. As the critical mass accumulated many layers of nationalist, religious, and even outright peasant characteristics, the center was itself transformed and translated to the right further. That shift was not discrete: it was rather continuous. Yet it remained visible and observable. The new center has increasingly become more nationalist and more religious. As such, it could not perform the function of containment and curtailment the old center was capable of doing vis-à-vis the far right. Nilufer Gole claimed, back in 1997 that since the center-right was rather inclusive of its own right at the margin, Islamists have been able to secure the development of their own technical and intellectual elite (Gole, “Secularism and Islamism in Turkey: The Making of Elites and Counter-Elites”, Middle East Journal 51 (1), 1997, pp. 46-58). The opportunity for social mobility has always been more real than virtual in the absence of nobility, and freedom of speech was genuine for both the Islamist and nationalist right. The newborn elite resembles the secular modernist elite they once opposed, even publicly criticized heavily. Gole’s central claim was that this process of elite formation had led to a de facto secularization, as possibly an unintended consequence of the actions of the conflicting bodies, as religion and professional career-building were mostly separate and distinct, even contradicting, paths. Before some turning point was reached, she was possibly right and, anyhow, she certainly had a good point back in 1997.The obverse course gained the upper hand, whereby the farright was able to recast the new center in its own image. The new center was no longer conservative only: it began to show shades of regression and was more prone to become a reactionary movement as time went by. As conservatism lacked bite, reaction took the pole position in its stead. What was only a potential in the 1950s became a reality in the late 1990s and especially after the 2001 crisis. Well, maybe this isn’t the end of the journey folks, but certainly a landmark has been passed. Economics and political aspirations don’t match though. 2018 will be key.