The battered Turkish lira has enjoyed a period of relative tranquility over the past two weeks. An emergency interest rate hike and soothing noises from senior officials appeared to calm nerves following a prolonged game of brinkmanship between President Recep Tayyip Erdogan and international investors that drove the currency to record lows. But the problems have not gone away.
Figures released on Monday showed a sharp rise in inflation. The lira strengthened in response, as markets bet that Turkey’s central bank would be left with no choice but to raise rates again when it meets on Thursday. The bank lifted a key rate by 300 basis points to 16.5 per cent on May 23.
As well as an annual consumer inflation rate that hit 12.2 per cent in May, up 1.3 per cent on the previous month, the country is also grappling with a wide current account deficit and heavy corporate debt burden. Both are funded by foreign financing that is being tempted away from emerging markets such as Turkey by a stronger dollar and rising US bond yields.
“The big picture is that Turkey remains vulnerable to shifts in market sentiment,” said Ugras Ulku, an analyst at the Institute for International Finance, a US-based think-tank. “That requires more careful economic management going forward.”
Turkey’s vulnerability is compounded by crucial parliamentary and presidential elections that were pulled forward by Mr Erdogan by almost a year-and-a-half and are now just three weeks away. Victory on June 24 would secure five more years in office for Mr Erdogan and usher in changes that radically enhance the powers of the presidency.
Officials from the ruling Justice and Development party (AKP) are nervous that the party, which has suffered fraying support in recent years, must court votes at a time of a weak currency, rising prices and economic uncertainty. But it is also difficult for them to tackle the problems’ root causes while on a campaign footing.
“Going into an election, it is next to impossible for any government to introduce anti-inflationary policies,” said Ilter Turan, professor of political science at Istanbul’s Bilgi University. “Tackling inflation requires belt-tightening measures and adjustments in interest rates.”
Instead, the government has announced a long list of pre-election giveaways and promised to counter rising fuel prices with subsidies as it seeks to keep voters on side. The problems have been exacerbated by Mr Erdogan’s tirades against interest rates and promises to tighten his grip on the economy after the election, which have spooked investors and hastened the currency’s slide.
One of the biggest concerns among Turkish officials is the impact on the private sector, which holds foreign currency loans totalling $295bn. The plunging lira, which has lost some 18 per cent of its value since the start of the year, has made it much more expensive for firms that borrowed in dollars or euros to service their debt.
Last week, Bloomberg reported that Gama Holding, an Ankara-based conglomerate, had become the latest company to ask banks to restructure as much as $1bn in debt. If the central bank fails to meet investor hopes of a rate rise this week, a renewed lira sell-off could force more companies to seek new terms on their loans.
The growing number of restructuring requests has raised questions about the fallout for the Turkish banking sector and the wider economy.
Moody’s last week lowered its growth estimate for 2018 from 4 per cent to 2.5 per cent, marking a sharp contrast with last year’s stimulus-fuelled growth of 7.4 per cent.
The rating agency Fitch announced that it was putting 25 Turkish banks on negative watch, meaning that they could be subject to a downgrade. It cited “heightened operating environment pressures resulting from currency and interest-rate volatility” as a key driver of the warning.
Analysts say that the Turkish banking sector remains strong thanks to an overhaul that followed a 2001 financial crisis. The sector’s average capital adequacy ratio is good at 16 per cent. But experts warn that non-performing loan ratios are higher than the official figure of 3 per cent, and are likely to rise.
“We expect a higher rate of bad debt provisions at Turkish banks and a lower appetite for lending, especially in foreign currencies,” said Gabor Kemeny, a partner covering central and eastern European banks at Autonomous Research, an independent research firm.
Many now see a slowdown or even a recession in the coming months. “There’s a big chance that we’ve reached a peak now and from here, growth can go only lower,” said Nora Neuteboom, emerging markets economist at the Dutch bank ABN Amro. “That would automatically lower inflation and the current account deficit so, in a sense, it would be a correction mechanism.”
Ms Neuteboom warned however, that the biggest concern for investors was Turkey’s reliance on foreign money. Turkey must find about $200bn a year to fund its wide current account deficit and maturing debt. With gross foreign currency reserves of just $85 billion, that leaves a significant shortfall if investor sentiment shifts and essential flows of “hot money” suddenly dry up.
“The major worry now is: will investors continue to be willing to fund this shortfall, even with interest rates lower than they would like?” Ms Neuteboom asked. “That’s the big dark cloud hanging over Turkey.”
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