The writer is chief investment officer of emerging market debt at FIM Partners
The warnings back in 2011-2013 were ominous: “If the Turkish lira breaks through 2 against the dollar, the economy will implode.” Once the 2 was reached, the new implosion target moved to 3, then to 5, and here we are at 13. The economy is still standing.
An economy with debt in dollars as high as Turkey’s should seemingly have imploded a long time ago under such currency volatility. The history of emerging markets is littered with balance of payments crises under similar foreign exchange depreciations.
There might be several reasons for this resilience. For one, up until earlier this year, the Turkish authorities did what they always had done in the past when confronted with capital outflows and currency weakness: interest rate hikes, if only belatedly and often in an obfuscated manner.
This boom-and-bust way of managing the economy kept the system going for quite some time. That time is what gave economic actors the chance to build buffers against an unbalanced economy. Banks, for example, kept balance sheets largely hedged on currency.
By virtue of a build-up of dollar deposits and a low level of foreign currency loans made relative to them, banks also had excess dollars. So they kept lending dollars to obtain cheap lira funding, creating in the process another safety mechanism for themselves.
But it hasn’t been only banks which have built resilience over time. As dollarisation progressed, households have continued to accumulate dollar assets but no foreign exchange liabilities. This is because banks were forbidden to lend foreign currency to households, making them a lot more resilient to currency risk. This was perhaps the regulators’ greatest foresight.
The creditor profile of the country has also changed over time. Fickle portfolio flows have greatly reduced. Foreigners used to own nearly 30 per cent of the local debt market but this number is now less than 5 per cent (a mere $3bn in absolute terms). Meanwhile locals now own almost 50 per cent of the country’s sovereign Eurobonds.
This has left Turkey more dependent on different types of external creditor — the syndicated loan market, trade finance, intra-corporate lending, or domestic lenders. These creditors are more patient, more long-term oriented than foreign portfolio investors.
The passing of time has also allowed Turkish corporates, the weakest link in the country’s external balance sheet chain, to reduce debt levels somewhat while building a positive net short-term foreign exchange position.
The problem, however, remains one of co-ordination. While on paper each economic sector has enough liquidity buffers of its own, they are all “joined at the hip”. One sector drawing on its foreign exchange assets has a ripple effect on the entire system, as those assets will be residing in someone else’s balance sheet.
Against that, the country is tentatively turning its persistent current account deficit into a surplus by virtue of the very large lira depreciation which boosts exports and contracts imports. Whether this turn in the current account, if it materialises, is yet another boom-and-bust episode or a structural manifestation of a policy-driven rebalancing of the economy remains unclear.
All in all, it’s been a surprisingly resilient journey, though longer than many of us would have anticipated. Turks also have suffered from high inflation and a squeeze in purchasing power in dollars. And the fact that Turkey hasn’t “broken” yet doesn’t mean it still can’t.
There is clearly a before-and-after President Recep Tayyip Erdogan’s dismissal of orthodox central bank governor Naci Agbal in March 2021, and the economic-logic-defying interest rates cuts that followed. The old policy playbook of belated hikes has seemingly been abandoned for good.
The foreign exchange equilibrium in the system remains too tenuous for the government to be confident an accident can be avoided.
Meanwhile, any touting by Ankara of a “new economic model” based on high savings rates and a cheap currency must be evaluated against high and persistent inflation, and the acceptance by the government of a painful acceptance of a contraction in demand.
Turkey was a very attractive destination for foreign lenders — a double-B rated, high-growth economy, with five per cent dollar yields, at a time the rest of the world was at zero. This context has changed for the worse. Whether the new creditors in town as well as the locals will take enough comfort from the existing economic set up remains an open question. But unless there is a change in policy direction, the government will be testing their limits.