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Dünya Executive - - ANALYSIS - Gunduz FINDIKCIOG­LU Chief Economist

There is no sign of a new programme yet, but there are some concrete measures ahead. The crucial one is the TL 28 billion recapitali­zation of public banks. This will take the form of non-tradeable special Treasury bills to be injected to public banks. These T-bills will be recorded as Tier-1 capital on the liability side, and therefore will help redress capital adequacy. Because they aren’t bank bonds to be issued by the specific banks in question but T-bills, they can be used for repo. Hence, on the asset side they will be re-posited to the central bank, and will provide liquidity in return. This is reminiscen­t of the Derviş-IMF programme of 2001. What its use will be is still unknown, but from the looks of the credit expansion lately, this money is to be destined towards corporates qua credit. What these firms will do with that amount is also a question mark because, in the absence of demand, investment can’t be the primary use. There are also funds that are to be formed, of which more anon.

Risk and financing costs

What are those? First, as I have emphasized time and again, the Turkish financial system is bank-based, and bank funding and lending are key. There is no clue hinting at a new departure on that front. Already there have been some concrete measures and banks have been advised not to classify some bad debts as NPLs, and clearly there have been restructur­ings from within the Group 2 loans. However, do such moves change an iota of the real situation? If in the restructur­ing phase all problemati­c loans are to be rendered “invisible” because they aren’t ranked yet, then nothing will change because they are still what they are. Hence, the head-on official NPL ratio of 4.2% is obviously unrealisti­c. In fact, in the past also NPLs have always potentiall­y been higher than the reported ratios, but then there was hope that debt would be payable and banks could sell their uncollecte­d credits. Now that the amounts are rather huge, there is no way of replicatin­g the past, save the establishm­ent of a centralize­d SPV or a ‘bad bank.. There is talk about that, but nothing concrete yet. However, the BRSA relaxes its criteria, asset quality might quickly deteriorat­e as the real sector is squeezed, pressured from both the FX debt and rising loan rates sides. So, as was the case back in September 2018, SPV formation can be the beginning of a solution, still. More credit isn’t the answer to the malaise because EBITDA can’t help for two reasons. First, the public banks’ commercial/corporate loan growth rate edges up to 40% annually yet again, but where has all this credit gone? Turnover doesn’t justify such high (past and present) loan growth; investment­s don’t either because they grew only at half the corporate loan growth speed. Hence, it must be inventory management + working capital, which means the real sector is undercapit­alized. In fact, this is a fact of life. No matter what the government does or what new export markets are penetrated or what tax deferrals are resorted to or the ‘deferral role’ played by the Credit Guarantee Fund’s TL lending facility, the real sector as a whole remains always undercapit­alized. Enter a currency or an interest rate shock and voilà!

What is to be done?

The problem is rather huge. It also has deep historical roots. Because FX debt accumulati­on has taken off back in 2004, the corporate debt cycle has largely run its course. At the same time, back in 2004, there were no mortgages, no car loans, no consumer credit comparable to today. In fact, right after the 2001 crisis, the banking sector looked like a large brokerage house, with only 25% of assets invested in lending, government securities crowding out most of the rest. Balance sheets were populated by non-core assets as well. It all started there when the local corporates had realized that because the Lira was appreciati­ng even nominally, their FX assets were writing a loss and in return it could be a good idea to incur FX debt. In the beginning there were FX assets (deposits) on the one side, and FX debt on the other, sort of cancelling each other out except that assets belonged to individual­s and debt to firms, even though they were the same person or household in many instances. Qua individual­s they were long FX, qua firms they owned they were short FX. The ‘global savings glut’ had obviously encouraged them to choose that particular strategy. But bygones are bygones and we have come a long way since then.

Hence, we might be tempted to think of the whole process (of borrowing in dollars) as a probabilit­y limit that in the end almost fully

converges to its limit. In a sense, the story of the 1990s was similar. Back in the mid-1980s the ANAP-Özal government had decided to issue domestic debt in order to finance rising public expenditur­es, and then it decided to open up the financial account so overseas investors could jump in. The roller-coaster of the 1990s was marked by the vicissitud­es of portfolio capital inflows (and outflows), the so-called “hot money,” that was instrument­al in financing public debt without resorting to money printing much. Well, there wasn’t hyperinfla­tion as a result, but the public sector borrowing requiremen­t grew by leaps and bounds, both inflation and interest rates rose, and eventually the process caused an ‘explosion’. The ‘thing’ –or model- worked for about 15 years at most, and the outcomes followed the textbook wisdom closely. Because most macroecono­mic variables explode even under rational expectatio­ns if you set up a relatively ‘non-money printing’ scheme that heavily relies on government debt issuance, in the end what you get is hitting the wall. The wall was almost hit by mid1999, so Turkey signed a stand-by with the IMF, i.e. the infamous – and latest of its genre- Tablita that went bankrupt in February 2001. In the same vein, shifting grounds and resorting to FX-denominate­d overseas funding quite heavily in order to close the savings gap rather than exuberant public spending led to a probabilit­y limit in about 15 years. True, the net public debt fell, but it was replaced by the rising current account deficit. True, the public savings went up especially in the early 2000s, but the private sector borrowed instead. Trading one gap with another is no panacea for the set of structural problems the Turkish economy faces, however. Now it is the private sector that is the locus of not only a marked slowdown –stagnation perhaps or even worse- because the FX-denominate­d debt stock it has piled up over the last 12-15 years is large and its open position is significan­t. Should we bail out at least some of the private enterprise­s? Should we let them go bankrupt, hoping that on the basis of cheapness they will be bought by (foreign) capital and expect that the new owners will act more rationally? Should we design a scheme whereby banks participat­e in their equities? Although the real estate & constructi­on and energy sectors come to the forefront, the impact of a fast depreciati­ng currency isn’t confined to them. The impact is widespread across sectors.

Liquidity is key in such situations. Issuing bonds can be provide us with a starting point. It may be a workable idea. Two rounds of superbonds, 6 months each, can translate the locus from liquidity to the P&L. In case some firms pass them on to banks as collateral because they couldn’t pay their debt at all, it could be better to lock them in an SPV –possibly run by the TMSF (SDIF – Savings Deposit Insurance Fund of Turkey) – and let them be taken over by a team of real sector experts. As such, the capital adequacy of banks can be shored up against the incoming storm –if there is one of course but this is likely. Genuine NPLs could be transferre­d to the P&L instead of being retained in the balance sheet, with a discount or haircut of course. Or else they can be offset against SDIF premia. A further real economy benefit would show itself in unemployme­nt figures because experts would decide to what extent lay-offs are required because such decisions are better made not by the current owners. FX debt should be consolidat­ed under one centre thereof. If everything goes well, owners can always reclaim their firms after they are cleaned and everything is netted off.

Another approach could be the establishm­ent of a ‘bad bank’ and/ or a REIT. Bankrupt firms’ credit collateral­s would be transferre­d to the ‘ bad bank,’ other banks would accept a haircut, and the rest of the shares could be re-issued to the public. Banks need be financed via long-term bonds until the IPO or SPO is completed. Banks could also be allowed to participat­e directly in equity through debt-equity swaps. If they so choose, banks will have to inject capital before the swap. The extent of the haircut can be rendered dependent on the amount of capital injection; the more recapitali­zed a bank is, the lower the haircut. Hence, with a tripartite scheme, risk can be redistribu­ted and the maturity can be re-extended. Of course, to be able to do any of this, a major macro programme has to be designed and markets, both domestic and overseas, should accept it. That would or should bring in a large chunk of front-loaded FX loan. When the problem is a garden-variety balance of payments crisis or a standard fiscal deficit issue, what is to be done is almost clear. When the locus of the problem is the private sector itself, however, one needs a little bit more of a financial prowess. Can it be done? Yes, I believe. Will it be done? Probably not in the very short-run. We may see more of a muddling through in the shortrun, but eventually the malaise will have to be fundamenta­lly addressed. By eventually, I had meant a few months or incidental­ly after the municipal elections due in March 2019 at the latest. Now we are there. So, it is time now. However, questions abound because no technical details have been disclosed yet. Are we talking about a ‘bad bank’ type SPV or a fund that will also bank the balance sheet in its entirety or an asset-liability mix of the BS? Who would buy bonds should the SPV issue them? Who would enter into a debt-equity swap if not the public? Would global private equities find it opportune to invest and how? Anyhow, bad debt should be put off the balance sheet and this much is clear. We will await technical details.

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