Emerging

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EcoEmerging// 4 quarter 2018  
economic-research.bnpparibas.com  
Turkey  
The tight-rope walker  
A currency crisis broke out in August. Beyond (geo)politics, the main reasons behind the collapse of the TRY are the worsening in  
Turkey’s macro fundamentals and erosion of the credibility of its policy mix. The authorities have limited room for manoeuvre and  
announced a tightening of economic policy, which has led to some respite in the financial markets. Reconciling with the West is  
also required to regain investors’ trust. Turkey’s economy is heading toward a text-book “boom and bust” cycle and stagflation.  
The macro adjustment is going to favour a narrowing of the current account deficit, but the country’s external financing needs will  
remain huge. Banks are the main channel for the transmission of balance of payments troubles to the real economy.  
Currency crisis  
1- Forecasts  
The Turkish lira (TRY) plummeted 20% against the US dollar (USD)  
in August, the most severe depreciation in a single month since the  
2
016  
2017 2018e 2019e  
Real GDP growth (%)  
3.2  
7.4  
3.0  
1.1  
2001 crisis and of the same magnitude as the currency’s plunge in  
Inflation (CPI, year average, %)  
Budget balance / GDP (%)  
Public debt / GDP (%)  
7.8  
11.1  
-1.9  
16.8  
-2.4  
18.9  
-2.1  
October 2008. The currency crisis has been latent for several  
months, with the USDTRY depreciating by 40% over the past six  
months. According to our calculations based on CBRT data, so far  
Turkey has not experienced a huge decline in foreign portfolio  
investments (-USD 2.5bn year-to-date including USD 0.8 bn since  
August 10). Meanwhile, FX bank deposits dropped markedly (-12%  
in USD terms since March or USD 23 bn, including USD 7.6 bn in  
August), driven by residents’ FX deposits (which account for 85% of  
total FX deposits). The latter have rebounded very slightly over the  
past few weeks. Carry-trade positions have also declined.  
-1.5  
28.3  
-3.8  
28.3  
-5.6  
30.2  
-5.4  
31.6  
-3.0  
Current account balance / GDP (%)  
External debt / GDP (%)  
46.9  
90.6  
53.3  
82.6  
63.4  
66.0  
60.6  
58.0  
Forex reserves (USD bn)  
Forex reserves, in months of imports  
Exchange rate USDTRY (year end)  
5.1  
3.5  
4.0  
3.8  
3.0  
6.1  
2.7  
7.0  
e: BNP Paribas Group Economic Research estimates and forecasts  
Apart from (geo)politics (notably US sanctions), the main reason  
behind the collapse of the TRY is the worsening of Turkey’s macro  
fundamentals and the erosion of the credibility of its policy mix.  
Mounting tensions between Turkey and the US have intensified with  
2- Foreign exchange rate, inflation and policy rate  
Inflation (y/y % change, lhs)  USDTRY (rhs)  
Weighted average cost of CBRT funding (% per annum, lhs)  
the Pastor Brunson crisis”. On August 10, the US imposed  
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3
2
1
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commercial sanctions on Turkey, which in turn announced  
retaliatory measures. The US is not a strategic trade partner of  
Turkey (only 6% of Turkey’s exports go to the US). Nonetheless,  
investors have feared further escalation in the diplomatic dispute  
and even a breaking of the two countries’ bilateral relationship. More  
fundamentally, in the context of emerging-market tensions, the  
rising US dollar and US bond yields, trade tensions, rising oil prices  
and increasing geopolitical risks, Turkey has been considered as a  
weak link amongst EMs due to overheated economy and increasing  
macroeconomic imbalances, both internal (inflation) and external  
16  
1
1
1
4
2
0
8
6
4
2
0
(
current account deficit). Expansionary fiscal policy and pressure on  
2011  
2012  
2013  
2014  
2015  
2016  
2017  
2018  
the central bank to cut interest rates have underpinned investors’  
concerns.  
Source: CBRT, Turkstat  
Three key milestones to regain investors’ trust  
if needed. With consumer price inflation reaching 24.5% y/y in  
September and producer price inflation exceeding 46% y/y mainly  
owing to the FX pass-through, even monetary tightening of such a  
magnitude might be not enough to re-anchor inflationary  
expectations.  
The authorities had no alternative but to announce a tightening of  
economic policy in September, which has led to some respite in the  
financial markets in recent weeks. Three milestones are required to  
reassure investors: 1/ strengthening the credibility of the central  
bank; 2/ giving pledges of fiscal orthodoxy; 3/ reconciling with the  
West.  
For the time being, public finances remain rather sound (low budget  
deficit and debt). But the three main credit rating agencies  
downgraded Turkey’s sovereign rating and most of the local banks’  
ratings. The government must give pledges of fiscal rectitude, at the  
risk of exacerbating the slowdown of the economy (cf. infra). In  
The CBRT, which is “structurally” behind the curve, bowed to  
pressure from the markets. It hiked its policy rate by 625bp to 24%  
on September 13 and stated that further tightening will be delivered,  
th  
12  
EcoEmerging// 4 quarter 2018  
economic-research.bnpparibas.com  
addition, the revival of the structural reform agenda, which would not  
bear fruit in the short term, may eventually be viewed positively by  
international investors. The government’s New Economic  
Programme (NEP 2019-2021) announced on September 20 calls for  
the end of its “growth-only” policy. It acknowledges the need for a  
rebalancing of the economy, fiscal discipline and transformation in  
manufacturing and exports. It also announces the upcoming stress-  
test on banks, which highlights the recognition of the corporate debt  
issue. As for fiscal policy, the government announced the  
suspension of some investment projects. It identified roughly 2% of  
3
- Industrial production, retail sales and PMI  
Industrial production (y/y % change, 3mma, lhs)  
 Retail sales (y/y % change, 3mma, lhs)  
Manufacturing Purchasing Managers’ Index (rhs)  
20  
60  
55  
50  
45  
15  
1
0
5
0
5
2018 GDP of savings (TRY 60 bn, half of which are investments)  
and additional revenue (TRY 16 bn) for 2019. But the markets have  
been puzzled by the lack of detailed measures and should judge by  
deeds and not by words.  
-
The two first milestones may be “a shot in the dark” if the tensions  
with the US do not abate and President Erdogan does not tone  
down his rhetoric vis-à-vis foreign investors. The release of Pastor  
Brunson on October 12 may pave the way for a warming of bilateral  
relationship.  
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10  
2015  
2016  
2017  
2018  
Source : Turkstat, Markit, BNP Paribas  
In the end, the government has continued to deny recurrent rumours  
since end-2016) about the implementation of capital controls  
Technical recession is looming  
(
Real GDP, of which growth moderated in Q2 2018 (5.5% y/y vs.  
.4% y/y in Q1), is likely to contract in H2 2018 and even H1 2019  
(higher taxes on FX deposits do not constitute capital controls).  
Resorting to the IMF’s financial support appears to be highly unlikely  
unless both the Turkish government and the US government (IMF’s  
main shareholder) make a U-turn in their policy stance.  
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as domestic demand shrinks, while global demand and the weak  
TRY continue to support exports. Despite a carry-over effect on  
GDP growth is 4.8% as of mid-2018, real GDP growth is expected  
to average 3% this year. As for 2019, the likely economic recovery  
in H2 should allow GDP growth to reach about 1% on average.  
Banks are the main channel for the transmission of  
balance-of-payment troubles to the real economy  
The financial sector (banks plus non-bank financial institutions) has  
to bear a large share (a little more than USD 100 bn) of the  
country’s external financing needs in the coming year. Banks are  
exposed to counterparty risk and the rollover in derivatives markets,  
in which the CBRT has become a major player since late August  
They are also exposed to double transformation risks (i.e. maturity  
risk, indirect FX risk) as 1/ they have used the FX swap market to  
close their FX position while financing TRY-denominated loans, and  
2/ they have lent massively in FX to non-financial companies.  
This scenario is consistent with high-frequency and advanced  
indicators. Confidence indices have tumbled in recent months.  
Industrial output and retail sales are slowing. The manufacturing  
PMI has been below 50 (the threshold between expansion and  
contraction) since April. Imports have slumped in August. Weekly  
data shows that growth in consumer credit has turned negative in  
recent weeks. The unemployment rate is increasing again.  
Facing huge external financing needs  
The macroeconomic adjustment that is underway should go hand-  
in-hand with a rapid narrowing in the current account deficit (CAD)  
in the coming quarters. In 2009, the CAD was divided by 4 to 1.7%  
of GDP in line with the 4.7% contraction in real GDP, while nominal  
GDP in USD terms declined by 15%. Since July, the trade deficit  
has begun to shrink thanks to dynamic exports, the slowdown in  
domestic demand and strong tourism receipts. It is worth noting that  
unidentified capital inflows (i.e. net errors & omissions) have  
increased very fast in 2018 (USD 8.3 bn in H1 2018), which has  
helped to support the balance of payments. Anecdotal evidence  
suggests that part of these inflows is constituted of repatriations of  
Turkish corporates’ off-shore assets.  
Fortunately, Turkish banks enjoy sound financial metrics, notably  
strong capital buffers. But further TRY weakness and pressure on  
FX liquidity are likely to increase credit risks arising from corporate  
debt distress and restructuring demands. Given the economy’s high  
level of euro-dollarisation, a drying-up of FX liquidity (i.e. a cut in  
external financing and/or a run on FX deposits) and rising interest  
rates would inevitably lead to further slowdown in bank lending or  
even contraction in credit and further deterioration in banks’ asset  
quality. Most of corporates FX liabilities are financial loans  
(USD 293 bn while import-related loans are USD 42 bn), of which  
about 60% are domestic loans and 40% external debt. The sectors  
that are the most vulnerable are 1/ energy 2/ transport &  
telecommunication, and 3/ construction.  
Nevertheless, Turkey’s external financing requirements (current  
account deficit plus external debt amortisation) are expected to  
remain significant (about USD 200 bn within twelve months). By  
comparison, official FX reserves stood at USD 68 bn (excluding  
gold) and the CBRT’s “free” FX reserves amount to only USD 28 bn.  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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