Promises must ensure a ‘soft landing’ for Turkish economy
There is confusion among cabinet ministers regarding how Turkey’s post-election economic outlook will look. Despite Deputy Prime Minister Mehmet Şimşek saying it would be a period of a “leap forward” of reforms, the cabinet declared a controversial tax amnesty a couple of days ago.
This happened just a few days after they boasted that the economy had grown by 7.4 percent, which made the Turkey the champion of economic growth among G-20 countries. If we really are the champion, why are we granting consecutive tax amnesties? If a new amnesty is granted at a time when the previous one has just expired it means that companies and tradesmen cannot afford to pay their taxes.
Whoever wins the election, it is most important to focus on securing a “soft-landing” instead of preoccupying ourselves with “lifting up the economy.” This means focusing on how to help companies that have large debts that they cannot pay off, as well as companies that are on the brink of bankruptcy and companies whose capital has simply eroded. The question is how to help such companies return to normal.
That is why politicians must focus on a “soft landing” not “high-flying.” Governing politicians may not want to face it, but the latest warning came from the rating agency S&P, lowering Turkey’s credit rating. S&P explained the reasoning behind the cut by pointing to the risk of a hard landing. It mentioned high inflation and the current account deficit, which is financed by borrowing, while also underlining the impact of the elevated foreign exchange rates on inflation and stressing that external debt is rising because of the exchange rate.
Şimşek said the downgrading and the fact that it was brought forward was meaningful. S&P pointed to the Central Bank’s recent rate hike, noting that this was insufficient to reduce by much the gap between inflation and the Bank’s five percent medium-term target, or to reduce the volatility of Turkey’s real effective exchange. It also noted that the Bank has not met its inflation target since 2012. The most recent inflation data, which was announced days after the S&P report, has confirmed these warnings.
S&P noted that asset quality has remained relatively resilient so far, with nonperforming loans (NPLs) amounting to only 2.9 percent of total assets as of March 31, 2018. However, this ratio alone does not reveal the “full picture” regarding potential problem loans in Turkey, according to the rating agency. If problem assets sold since 2010 are added, the NPL ratio increases by 1.5 percentage points, S&P stated. Furthermore, restructured loans in regulatory classifications represent a further 3.8 percent, it added. Hence, when adjusted to include problem asset sales by large Turkish banks, as well as restructurings not included in NPLs, the NPL ratio rises to high-single-digits such as 8.2 percent. It emphasized that there is recent evidence of rising distress in pockets of the corporate loan book and the fact that the debt of several highly leveraged borrowers recently had to be restructured, including the debts of Yıldız Holding and Doğuş Holding.
S&P stated that Turkish banks have a structural lack of long-term lira funding, which makes them reliant on swaps to close their currency positions. They use currency swaps to convert not only borrowing in foreign currencies, but also high amounts of domestic deposits in foreign currencies, owing to the use of dollars to fund lending in lira. If one or more of these institutions is potentially subjected to U.S. sanctions, there will be a risk of not being able to renew these positions.
Pressure on interest rates
It would be naive to suggest that Ankara is unaware of the difficulties being faced by companies and lenders. So let’s stress once again: The main theme of Ankara’s economic policy, both prior to the June 24 elections and afterwards, should be measures to be taken for a soft landing. But with the recent “election package” public finances will take a battering, with a further 24 billion lira added to this year’s expected budget gap of 65 billion liras.
This deficit will obviously be met through additional debts. At a time when banks cannot show a sufficient TL-denominated liquidity and there is a shortage in foreign capital inflows into the country, we will likely see a rise in interest rates. Both an eased monetary policy and fiscal policy will put further pressure on businesses’ financial costs, which are already under parity strains. Economic policy is becoming so uncontrollably loosened that a soft landing is becoming increasingly difficult.