Economic cliffhanger on the Bosporus! Currency, stock markets and economic growth are in free fall. The Erdogan administration must radically transform its economic policy quickly and restore the independence of the central bank. But so far there has been no real sign of anyone relenting. The situation is becoming more and more precarious with each passing day.
It has taken some time, but the limits of the economic reality of President Erdogan’s policies and decisions have become apparent once and for all. This was finally triggered by the increasing influence of politics on the decisions of the Turkish central bank and nepotism in the appointment of the government posts. This has noticeably dampened the confidence of foreign investors in Turkey’s continued economic policy and has ultimately led to the drastic depreciation of the Turkish lira. Yet Turkey is greatly dependent on the trust of foreign investors. After all, the country has a high current account deficit to finance.
There is much to suggest that Turkey will need international aid in the near future if it is to avoid becoming insolvent. The crisis naturally also has a political dimension. Turkey is centrally located in Europe and a potential power vacuum is something that this region can ill afford at present. Chances therefore exist that a European solution will be aimed at even if there have recently been major differences between Turkey and many European countries, most notably Germany.
How high the risk of contagion is for other emerging markets depends above all on the structural stability of these countries. If this is sufficient, the risks are fairly low and some reactions on equity markets may have been somewhat exaggerated. Nevertheless, the overall number of significant risks is constantly increasing, and this is slowly but steadily undermining the attractiveness of equities.
The fact that the Turkish lira is very vulnerable to a deterioration in investor confidence is not least due to the state of the country’s external balance sheets. Turkey’s overall position here must be described as weak. The first argument for this is the country’s chronic current account deficit. This is largely attributable to the trade and income balance, while the services balance (keyword tourism) regularly shows a surplus. Last year, the decline amounted to 5.6 percent of gross domestic product (GDP) and is estimated to exceed 6 percent of GDP in 2018. This is a high rate – also in relation to other emerging markets.
Further key ratios additionally underscore the country’s weak position. For example, the structural current account deficit in conjunction with the ongoing debt servicing has made Turkey greatly dependent on regular external financing. The International Monetary Fund (IMF) estimates this financing requirement for 2018 and the coming years at just over 25 percent of GDP (i.e. around USD 230 billion). This is a comparatively high rate for an emerging country. At the same time, Turkey’s currency reserves are too low. Including gold, these amount to only around USD 100 billion or around 10 percent of the GDP estimated for 2018. This leaves only a modest reserve for servicing the external liabilities and for a possible intervention in favour of the lira.
Turkey’s external debt is essentially not that high compared with other emerging countries. At the end of 2017, it accounted for only around 54 percent of GDP and was thus lower than in some Eastern European countries. However, the maturity structure is unfavourable. Around 74 percent of foreign debt is recognised as long-term debt which means that around 26 percent (USD 122 billion) can be recognised as short-term – thus making it susceptible to a rapid withdrawal of lenders. The banking sector accounts for approx. USD 69 billion of this and the corporate sector for around USD 53 billion. The short-term external debt of the public sector is negligible. Short-term foreign debt is offset by the reserve position of around USD 100 billion so that the short-term foreign liabilities are greater than the currency reserves. This is not often found even in emerging markets.
The causes of the current lira crisis are well known: the latest measures undertaken by the Turkish central bank and financial watchdog may suffice for a brief stabilisation. However, the Turkish government will have little other option than to change its policy, especially regarding the central bank and its independence, if the country is to be led out of the crisis over the long term. The problem here is that the Erdogan administration is currently showing little intention of adopting this course of action. The possibility of a renewed escalation of the situation therefore remains on the agenda in the weeks ahead. Against this backdrop, Turkey could also find itself dealing with a balance of payments crisis in the foreseeable future.
At the political level, the Ankara leadership has a trump card up its sleeve that should not be underestimated. The European Union can ill afford an unstable Turkey given the ongoing refugee problem. And the prospect of a NATO partner being driven into the arms of Russia or China is also likely to cause some sleepless nights in Washington. A compromise at the international political level is therefore possible at any time and could lay the foundation for calmer times and (economic) sanity on the Bosporus as well as on financial markets.