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26 I Cover story bne June 2018
Turkey’s debt-fuelled dive
bne IntelliNews
The lights are flashing red in Turkey as the tumble of the lira threatens to trigger a debt crisis. Heavy foreign borrowing by the country’s corporates and banks has exposed the economy to foreign exchange risks that are starting
to hit now. As far back as April 16, Moody’s Investors Service warned that the prolonged weakness of the lira combined with high inflation would likely drive up problem loans for Turkey’s banks.
“The lira’s decline will lead to higher loan-loss charges that reduce banks’ profitability and capital ratios, which would raise the risk the availability of foreign funding would decline,” Moody’s said. “Because 33% of Turkey’s bank loans at year-end 2017 were denominated in foreign currencies, primarily US dollars and euros, if the lira’s exchange rate versus the dollar remains at or above last April 11’s all-time low of TRY4.15, problem loans will increase. A sustained depreciation of the lira will reduce the repayment ability of corporate borrowers that have no foreign currency revenue and are unhedged.”
It also stated: “Ongoing lira weakness is especially problematic for Turkey’s economy because of its high degree of external vulnerability and low foreign- exchange reserves, a credit negative for the sovereign. In 2017, the current account deficit widened to 5.6% of GDP from 3.8% in 2016, reflecting higher oil prices and strong import demand. The growth in imports more than offset a double-digit increase in exports of goods and services, which was driven
by increased demand from trading partners and a recovery in tourism. But because Turkey’s exports have an unusually high import content, a weaker lira is a double-edged sword for the current account.”
Turkey, stuffed to the gills with hard-currency debt, is badly exposed by the severe devaluation of the TRY. The country’s overall stock of private
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Citizens would ultimately hold the presi- dent responsible for any problems gener- ated by monetary policy. “They will
hold the president accountable. Since they will ask the president about it, we have to give off the image of a president who is effective in monetary policies,” he said, adding: “This may make some uncomfortable. But we have to do it. Because it’s those who rule the state who are accountable to the citizens”.
Cue accelerated lira-dumping. Cue
utter disbelief. “Erdogan unchained,” strategist Timothy Ash at BlueBay Asset Management immediately called him. As the lira went from hammering to ham- mering – it was racing towards a star- tling five-to-the-dollar by the early hours of May 23 as even previously faithful Japanese margin traders cut their long lira to yen positions. Financial market investors struggled to find remaining reasons for why they shouldn’t just pull out of Turkey.
As one investor told Reuters: “Why the hell would you come to London, and basically send this message to institu- tional investors which is exactly what they did not want to hear?”
What was seen by critics as Erdogan’s surrender to classic monetary theory brought an emergency rate hike of 300 basis points (bp). This helped drag the lira back from levels near the all-time low of 4.9294 to the dollar recorded early on May 23, taking it into the 4.60s, but that rate is still regarded as unprece- dentedly bad and the markets are clearly demanding even heavier policy action sooner rather than later.
A classic crisis
Warnings that the currency market
rout could presage a financial crisis in Turkey are spreading. Writing in The New York Times on May 24, Nobel Prize-winning economist Paul Krugman said: “What’s happening in Turkey is
a classic currency-and-debt crisis, of a kind we’ve seen many times in Asia and Latin America. First, a nation becomes popular with international investors and runs up substantial foreign debt – in Turkey’s case, largely debt owed by domestic corporations.”