Outlook 2020 – TURKEY
Government insists worst is over, but reliance on public debt to manage private debt bodes more trouble ahead
The Turkish economy on the surface appears to be making a shockingly quick comeback from its collapse. But in reality, economists believe it is more like a patient on life support, breathing through cheap credit and public subsidies to firms, in a state-backed Ponzi scheme.
Since the final quarter of 2018, after a currency crash in August of that year wiped 30% off the value of the Turkish lira, the Turkish economy contracted for three quarters. The third quarter of 2019 saw positive year-on-year growth, but given the high external debt of the private sector, a current account deficit, high unemployment and dependency on international capital inflows, economists were nearly certain that this economic crisis (the fifth since the end of the 1970s) would require a long and painful recovery.
Yet thanks to public expenditure and expansionary monetary policies, Turkey saw a positive growth rate after only three quarters of contraction. More surprisingly, the economy shrank only -1.39% in recession (during the 2009 recession the growth was -5%) since the final quarter of 2018.
That, however, was according to the official statistics.
The final quarter of 2019 will show if the economy is really recovering or the statistics have been manipulated, a major question among economists. The Turkish lira has already been subject to government intervention through the implicit manipulative actions of public banks in domestic and international financial markets.
Moreover, President Recep Tayyip Erdoğan and his AKP regime have yet to come up with a plan to tackle private sector debt, the main problem after the currency crisis that led to Turkey’s current mess. Instead, the AKP insisted on cosmetic and forced temporary fixes to save the day and showed that it will prefer to use public debt to manage private debt, an official Ponzi scheme.
In Turkey, an already highly-indebted private sector has been provided cheap credit since 2016. Zombie firms have reportedly been kept alive by cheap, publicly supported loans. After a fourth major interest rate cut from the Turkish Central Bank since the 2019 currency crisis, the policy rate dropped to as low as 12%, or half the initial crisis level, as Erdoğan wished badly.
Throughout 2019, reports persisted that Ankara would broker agreements for restructuring loans between single firms and banks. A comprehensive plan for private debt appeared inevitable but it never came. The main reason was the weakening political power of Erdoğan. Such a plan would require hard decisions over which firms would be left to go bankrupt and which ones should be rescued. Erdoğan and his embattled AKP cannot afford the resentment of any capital groups.
Instead, a partial agreement was announced by Turkey’s Banking Association (TBB) on October 14, more than a year after the currency crunch, and only after the national financial regulator ordered the country’s banks to reclassify 46 billion lira ($8.1 billion) worth of loans as non-performing (NPL) by year-end, and to set aside reserves to cover the losses.
Turkish banks held some 139 billion lira in NPLs by December 2019 (5.4% of total loans), up from 88 billion lira a year earlier. The government wants the banks to start lending again, and writing off the not restructured debt as NPL would clear banks’ balance sheets to start lending again. The fourth-quarter growth will depend on whether the private banks and firms can begin to use this “opportunity.”
Despite the high gross external debt (61.9% of GDP by the second quarter of 2019) and dollarization (residents’ FX deposits reached US$194 billion, almost 52% of total deposits), and thanks to favorable international liquidity conditions and lower import demand by companies due to the downsizing of the economy, the Turkish lira has been stable.
The lower demand for foreign currency by the private sector and collapsed private demand pushed consumer inflation down to 10.6%in November (after reaching as high as 25% in October 2018). Decreased inflation made room for interest rate cuts. Yet the economy remains fragile, and international financial markets may turn against Turkey’s interests in 2020. With the real interest rate barely above zero after the latest cut, Turkey may lose its competitiveness for foreign short- and medium-term funds – funds it needs badly to keep interest rates low.
The Turkish Central Bank decreased interest rates on the basis of favorable conditions in international financial markets as central banks of developed countries began easing their monetary policy under recession fears. The central bank board’s final meeting notes refer to a slowing down in international trade, particularly in Europe, the main trade partner of Turkey. This is particularly critical because along with public economic activities, the contribution from net exports has been the main controlling source behind the relatively low shrinkage in the economy during the 2019 recession.
The third-quarter growth statistics confirm the central bank’s concerns as the contribution from net exports to the national income turned negative (-0.2% down from 6% in the second quarter). While imports, particularly investment and intermediary good imports, decreased radically until the third quarter of 2019 – which helped turn the high current account deficit into a surplus in a year’s time – growth in exports stayed moderate for two quarters. In the third quarter, growth in exports was only 5.1%. Hence, Turkey should turn to domestic markets as international trade prospects for 2020 do not appear promising.
Instead, however, the government is pushing credit expansion at a time of high private debt, high unemployment, relatively high inflation, low purchasing power of households and very low investment. The contraction in investment is particularly worrying. High and stubborn unemployment along with a serious decrease in investment is damaging future growth prospects of the economy, and the government does not seem to have any clue how to deal with it other than pumping credit to the already indebted firms. It is very likely that zombie firms will use the new wave of publicly subsidized cheap loans to roll over their debt stock.
Is it really over?
On the eve of 2020, Erdoğan’s AKP regime has insisted the past year’s crisis is over, but economic and social statistics do not support their stance.
Turkey has had a persistent, high unemployment rate since 2005. The average unemployment rate of the last four quarters was 13.5% and since hitting 14.5% in the second quarter of 2019, has remained at that level.
Without a growth rate of at least 5%, farfetched for the coming two years, the Turkish economy is not capable of creating new jobs. More worryingly, the youth unemployment rate and broad unemployment rate (unemployed plus those who have given up looking for jobs) have hit all-time highs of 27.2% and 20.89% respectively.
These numbers, particularly regarding youth unemployment along with the share of unemployed people who have been out of work longer than a year, raise concerns over the path which the economic crisis will take in the coming years. There is a wide body of academic literature showing that people who are out of work for a long time have a smaller probability of finding a job even when the economy is on the rise. This suggests that in the coming years long-term youth unemployment will damage Turkey’s productive labor force, which will worsen Turkey’s growth potential. Moreover, brain drain among highly educated young people has been exacerbated by the economic crisis.
The phenomenon of family suicides in Turkey, which have made the news in the last couple of months, have two common characteristics: a long period of unemployment and poverty. Given the fact that inequality and poverty have been on the rise since 2015, social tensions are set to keep building in 2020.
The other deficit
While the Turkish private sector tries to pay its debt back, public debt is on the rise. The ratio of public net debt stock to GDP increased from 8.7% in the second quarter of 2018 to 14.5% in the same term in 2019. This creates further pressure on interest rates and another fault line to economic risks.
The government this year directed public stimulus to unproductive areas, namely mega-projects like Canal Istanbul, which it plans to continue to support in 2020.
Moreover, the budget of Erdoğan’s regime has become increasingly unaccountable and nontransparent, while corruption allegations have been on the rise. Due to Turkey’s dependence on intermediary and investment goods, when the country begins to see positive growth thanks to credit expansion and public stimulus, the current account deficit will appear again. And this time, the budget deficit will be present as well, creating more pressures on interest rates, currency and inflation.
It does not matter if the recession is over or not, three quarters of contraction have already made their impact on the Turkish people. Economists predict there will be no more than 3% growth in the next two years, contrary to the very optimistic 5% target of the economy minister, Erdoğan’s son-in-law.
High unemployment, particularly among young people, predicts a rather dark picture for the medium-term economy, as does the heavy brain drain – ongoing since the suppression of democracy by Erdoğan. Turkey is set to carry cumulated economic, social and political problems of the past into 2020.