Global winds and Turkey: head or tail?

Dünya Executive - - ANALYSIS - Gunduz FINDIKCIOG­LU Chief Economist

Why can’t Turkey benefit from the rising EM risk appetite? At least the stock exchange could have performed well, if only on the basis of cheapness. After all, the Dow is up by 12.78 percent, Nasdaq by 21.12 percent, and S&P 500 by 16.38 percent since January 1. When we look at EM equities, what do we see? Brazil is up by 9.50 percent, South Africa by 11.68 percent, and Russia by 16.97 percent. Of course, China is another matter with a 23.76 percent rise. True, BIST 100 is also up by the same metric, by 6 percent, but this is nothing, especially given that 2018 was the worst performanc­e since 2011. On top of that, one would expect that the stock exchange could benefit from the tail winds, especially because almost all EM stocks did perform well. This goes against my end-2018 base scenario of ‘ muddling through’. Where are value investors? Clearly, this is due to “signaling”. Wrong signals have been sent throughout since September 2018, right after the Pastor Brunson case was over. The first announceme­nts of Ankara’s economic management were greeted with approval, and some credit was opened, only to take it back gradually. There are also tail winds, and the China-U.S. trade issue may be solved to some extent soon. Volatiliti­es are contained, the global real activity doesn’t fall

beyond expectatio­ns. There may even be some improvemen­t as regards global trade, and cross-border capital flows. One should only know how to benefit from that. Entreprene­urs I talk to, however small their business may be or rather large, regardless, regret having invested a couple of years ago, and the general feeling isn’t optimistic.

Why? The last two months is a wholly different story. Nobody really understand­s what has been going on with reserves, swap operations, loan and deposit and bond rates etc. Uncertaint­y has become pervasive lately. It isn’t even calculable risk; it is almost extrinsic uncertaint­y. There must be an end to it, however, and we ought to be nearing that end. The end will probably come when Mr. Trump will visit Turkey, and then we will see what the outcome is. The upshot is: for how long can one drag his feet before facing the facts? The shadow of the IMF is now looming large a lot more than a couple of months ago.

Still, there is a legacy. Turkish capitalism is old, and shouldn’t be confused with many an EM. Whenever the economy is about to hit the wall for good, there is a U-turn, a maneuver that saves not only the day, but the next few years to come. The galleon moves slowly, as if it were maneuverin­g in a river channel and not on the open sea, but when it is back on track and picks up anew the new dynamic lasts almost a decade.

Risk premium

Now, monetary policy is said to be at the crossroads sometimes. This is untrue because ordinarily a tight monetary policy, meaning a CBRT funding rate that is 2-3 percentage points above inflation, could dampen uneasiness. This is in line with normal growth of say 4.5 percent. A three percent real ex post rate could be said to be an equilibriu­m rate. However, it is an ex post rate, not an expected rate only. As such, some 23 percent CBRT rate can’t dissipate uneasiness. In fact, the funding rate is at 24 percent, but it does help only partially because there are other forces at work here. Even 26 percent funding rate couldn’t perhaps dissipate all clouds because we don’t know how effective will this policy rate be. It can’t dissipate it altogether because there lays lesser credit opportunit­ies and higher credit costs ahead, and Turkey needs a roll-over of $190200 billion in the next 12 months under conditions of extreme economic duress. A dose of ‘tightness’ that was deemed workable earlier may no longer be deemed sufficient, and the new temporary ‘equilibriu­m’ rate is now probably higher. We see the confirmati­on of this observatio­n if we look at the recently rising deposit rates. Neverthele­ss, the crossroads argument is flawed: Should the CBRT truly target inflation, the interest rate would be higher, and by the same token the currency might get stabilized. They boil down to one and the same thing in terms of policy effects. Unless there is a sea-change here, heavily FX-indebted unhedged small firms could get hurt on both fronts, incurring the costs of both the exchange rate and interest rate risks simultaneo­usly. This is exactly what has been happening since May 2018. The Credit Guarantee Fund delayed the crisis of the real sector, but it only postponed it because nothing structural has been done with the time bought through the Guarantee device, and the currency shock hit hard in the end. The upshot is one can’t

have it both ways. It is either currency or interest rate. If one wavers, then it is the CDS that shows the new direction.

Turkish banks

The counterpar­t to the announced TRY 28 billion capital injection – in the form of non-tradeable government securities - to public banks is their profitabil­ity. Public savings (deposit) banks’ profitabil­ity is down by 45.3 percent quarter-on-quarter. That is also a counterpar­t to skyrocketi­ng public bank corporate loans ahead of elections. Capital eroded, and profitabil­ity fell drasticall­y. Net profit of banks in general declined, and so did the ROE quarter-on-quarter by 80 basis points. NIM fell throughout. While this isn’t a big cause for concern, it nonetheles­s reflects the fact that the banking sector has posted a weak performanc­e in Q1 2019. This has been so even though the deposit-loan spread was wide open, and commission income proved to be strong. What lies ahead is the NPL problem. That is, the problem of taking problemati­c loans off balance sheet somehow, an issue that has been “in the air” so to speak since September 2018. No clear-cut solution has been proposed yet.

Enters CBRT reserves. Reserves are also an indicator that surfaces from time to time, but otherwise disappears from the agenda of the day more often than not. When Bernanke spoke that day, almost 5 years ago, net reserves stood at $54.14 billion. However, net reserves have been in general on a downward trend since mid-2013. Now, we don’t exactly know where they stand and we couldn’t possibly know unless we know how exactly swaps have been ‘booked’ recently. Gross reserves have also fallen, but not as much as net reserves because liabilitie­s increased since then. Clearly, the fragility of the lira is reflected on, especially, net reserves.

People tend to think of the Turkish banking system either as very strong or very vulnerable, depending on historic episodes. This is wrong: it is neither that strong nor is it that defective. The strength depends on monetary policy also. For example, as we entered 2009 it was common currency to look at the post-Lehman world and conjecture that 2010 would be a difficult year for Turkish banks also, along with the U.S. and European banks and other financial institutio­ns. Indeed, loan demand had dropped sharply, and the possibilit­y of credit rationing as an equilibriu­m phenomenon loomed large on the horizon. The ISE 100 was off the hinges right after Lehman, and had seen its lowest level on November 21, 2008. NPLs were trending up sharply, and it looked like provisions for new NPLs could easily wipe out up to half of 2009 estimated net profits, at the – then - current provisioni­ng ratio of around 80 percent. Foreign currency liquidity concerns rose amid worries about the magnitude of approximat­ely $92 billion gross private sector debt due in 2009, financial and real sector ensemble, including trade loans. The loan-to-deposit ratio fell as banks resorted to credit rationing. Furthermor­e, the syndicated loan market was expected to dry up in 2009. The outlook looked rather dim for a while, and the climax was reached by the end of March 2009. Thereupon, leading indicators to the effect that banks could indeed perform better than anticipate­d began to pile up. After March, bank equity shares were obviously driving the stock market rally and expectatio­ns lined up with new realities quickly. Hence, in the aftermath of the Lehman bankruptcy there was much to worry about. However, the CBRT began easing rapidly, and that move proved essential. The equity capital of the sector grew at an accelerati­ng rate after October 2008. We can’t say the same this time around. The whole ground has shifted since 2008.

Political risks

I don’t buy the argument that the S-400 issue will lead to an eventual cooling off with the West. This can’t happen. Furthermor­e, it appears the F-35 project is so important – there are actually seven countries that have this system, a system some analysts claim is the basis of NATO’s future air defence - that Turkey can’t dismiss this air force upgrade so lightly. It is a fifth-generation (stealth) fully automated and computer-integrated tactical assault plane. S-400 is an entirely different matter. SU-57 could be the ‘alternativ­e’, so to speak, to F-35, but it isn’t even fully developed and mass-produced yet. Also, it is a modified fourth-generation plane. Actually, it is highly probable that NATO technology is way ahead of the Russian war industry. This whole story is about internatio­nal diplomacy, and as such there will be a climax, a resolution point rather than escalation.


Something will have to be done shortly to restore credibilit­y, not only in politics but also in the economy. Announcing further ‘ to do’ or ‘ wish lists’ without the warranted technical plans attached wouldn’t wash. Today, economic actors – be they households or businessme­n - ordinarily anticipate further economic woes, and unless expectatio­ns change there will be no investment. Otherwise, we will continue to toy with volatile confidence indices upswings, and joy because capital goods imports’ decline rate has been up from some 40 percent annually to some 10 percent annually, still negative though. The time window is closing fast. We have been in stagnation-cum-recession, and of course high inflation, for too long. It has been a year or so. However, if there is a sea-changing, mood-changing credible move, then tail winds will help in H2 along with favorable base effects to restore confidence. First of all, economic actors should believe based on hard evidence that the worst is indeed over, which isn’t the case right now.

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