Robin Brooks, economist, IIF
Turkey’s recent growth path is heavily influenced by a series of credit expansions. A large credit boom two years ago, in part due to government incentives via the Credit Guarantee Fund, set the stage for very rapid growth in 2017, with Turkey outperforming essentially all its emerging market peers. However, that credit boom came at a cost. It widened the current account deficit sharply, increasing Turkey’s dependence on foreign capital inflows, which left the country vulnerable to last year’s “sudden stop” in the balance of payments. That “sudden stop” transformed the external picture, with the current account registering large surpluses in the second half of 2018, the result of a big decline in domestic demand. Understandably, the sharp drop in GDP – even as it reduced external vulnerability – has been a challenge for the country, and state banks stepped up lending in Q1 of 2019 to buffer activity. Unfortunately, this latest credit expansion again coincided with rising volatility in the exchange rate. The underlying reality is that increasingly volatile global capital markets are unwilling to fund heavily creditdependent growth models. A shift to less credit-dependent growth, including via structural reforms, is needed. As in 2017, that focus on growth has had negative repercussions for the external picture, with import demand rising, which in turn pushed adjustment of the trade balance into reverse. We estimate that the credit expansion is likely to have pushed the current account back into deficit in Q1, to the tune of -1.6% of GDP. We see this shift, which in turn reflects the Q1 lending boom, as the underlying driver for recent Lira volatility, even as rollover rates on external debt remain relatively stable, albeit low. This means that the recent rise in external vulnerability is the direct result of a renewed emphasis on creditled growth, which volatile global capital markets are unwilling to fund. The way forward is to shift away from credit-based growth, including via structural reforms.