Turkey: total meltdown

The Turkish lira is in total meltdown.  It has lost 40% of its value against the dollar in the last six months and fell nearly 20% in the last week.  The turkeys have come home to roost on the country’s economy and the erratic economic policy of its autocratic (recently re-elected) leader, Recep Tayyip Erdogan.

What triggered the crisis was when the US imposed asset freezes on Abdulhamit Gul, Turkey’s justice minister, and Suleyman Soylu, interior minister, for their alleged roles in the detention of Andrew Brunson, an American pastor. Mr Brunson, who ran a small church in Turkey for two decades before he was arrested in October 2016, is accused of participating in a conspiracy to topple Mr Erdogan. The pastor has described the charges as “slander”. His detention is just one of a number of disagreements between Turkey and the US that range over divergent stances on Syria to the delivery of US arms.

Then on Friday, Wilbur Ross, US commerce secretary, said the US would double the tariff on imports of Turkish steel to 50 per cent, because the previous level of 25 per cent had not been enough to sufficiently reduce Turkish exports to the US. “Doubling the tariff on imports of steel from Turkey will further reduce these imports that the [commerce] department found threaten to impair national security,” said Ross.

That was the trigger but it was not the revolver that now is pointed at the head of Turkey’s economy.  That was the fast deteriorating economic situation.  After the botched attempted military coup against him in 2016, Erdogan launched a credit boom to boost the economy while locking up thousands and sacking even more from their jobs in academic and government positions.  He insisted on keeping interest rates low and blocked any action to curb fast-rising inflation by Turkey’s central bank, describing interest rates as “the mother and father of all evil”.

Turkey’s capitalist economy could not handle this, just at a time that the US dollar strengthened after the US Federal Reserve began to raise US interest rates.  The problem for Turkey, a country without energy resources and only its human expertise and cheap labour to sell is that the vast majority of the funding for industrial development, construction and real estate comes from abroad:  American and European investors.  Turkey’s citizens and companies borrow significantly in dollars and euros.

The apparently fast economic growth of the last two years was built on turkey legs (credit and foreign borrowing) while imports flooded into the economy not matched by exports and the profitability of Turkish capital fell sharply.  The rise of the dollar and interest rates globally brought an end to the party and has exposed Erdogan to the realities of global capitalism.

Turkey banks and corporations are now in dire trouble. Turkey’s non-financial companies’ foreign currency liabilities now outstrip their foreign exchange assets by more than $200bn.

The country’s banks and corporations have billions of dollars of hard-currency debt coming due.  Turkey’s banks are scheduled to repay $51bn over the next year, while the remaining $18.5bn sits on non-financial corporate balance sheets. These bills are coming due at a time when corporate indebtedness sits at 62 per cent of GDP, half of which is denominated in foreign currencies (dollars and euros, mostly).

Foreign investors are now worried that Turkey will not be able to finance this.  Relative to its short-term external debt, Turkey’s FX reserves have declined to new lows.

So capital has fled the country and the lira has tumbled.

Now the extra worry for global capital is that if Turkey’s banks and corporations start defaulting on their debt servicing, then European banks could suffer significant losses on their own balance sheets – what markets call ‘contagion’, the spreading of losses and default internationally.  Some of Turkey’s banks are foreign-owned and the biggest lenders to Turkey are Spain’s BBVA, Italy’s UniCredit and France’s BNP Paribas.

Turkey’s banks appear to have plenty of reserves and loans to Turkey are just a small part of total loans made by these foreign banks.  But even ‘marginal’ losses can sometimes be a tipping point when profits are tight.  And bad debts in the banks have already been rising (% of debt that is ‘bad’ graph below)

How can Erdogan get out of this currency crash?  The capitalist solution is to hike interest rates to an astronomical height so that further borrowing is stopped.  Then the government should dramatically cut government spending and raise taxes (ie fiscal austerity) and use the ‘savings’ to bolster the banks and meet foreign debt repayments.  Turkey should also turn to the IMF for a loan – Greek style.  Under IMF rules, it could borrow up to $28bn to fund future debt repayments but then be subject to the dictats of IMF austerity measures.  This capitalist solution means an outright slump in the Turkish economy, hitting its citizens hard and seriously damaging Erdogan’s support in the country.

The government could introduce capital controls and block any money leaving the country.  But this would mean that foreign lenders would just stop lending, driving the economy into a slump anyway.  Or Erdogan could try to get funding from Russia, China or Saudi Arabia (as Pakistan has just done).  Unfortunately, he is on bad terms with all these countries.  Erdogan is resisting all these options so far, telling his supporters to ‘trust in God’ and him.

The bigger issue is the growing emerging market debt crisis. This is what I said in May after Turkey’s general election. “Rising global interest rates and the growing trade war initiated by US President Trump are going to hit the so-called emerging capitalist economies like Turkey.  The cost of borrowing in foreign currency will rise sharply and foreign investment is likely to reverse…..Turkey is now near the top of the pile for a debt crisis, along with Argentina (already there), Ukraine and South Africa.”

So there’s more to come.