The Global Crisis Reaches Turkey

Özgür Orhangazi, Guest Blogger

Since the late 1970s, “developing and emerging economies” (DEEs) have experienced boom-bust cycles of private capital flows that led to severe crises in most cases. The latest boom began in the aftermath of the 2008 U.S. financial crisis, fed by the quantitative easing policies of the Federal Reserve and the European Central Bank (ECB). Much of Fed’s injections of credit into the system ended up in the stock markets of advanced economies and even more in the DEEs.

This latest wave of capital flows into DEEs led to currency appreciations, growing current account deficits, credit expansions and asset bubbles. As Akyüz (2013) has noted, this boom “has been creating or adding to macroeconomic imbalances and financial fragility in several recipient countries in large part because they have been shy in applying brakes on them” (p. 89). The way that these boom-bust cycles begin is usually similar (e.g., rapid expansion of liquidity and low interest rates in the United States), but they end in different ways. This time the decision of the Fed to “taper” its injections created a slowdown in capital flows to these economies.

Turkey is a case in point. While in the last decade it gained praise for its strong growth performance, now it is considered to be among the “fragile five”, together with Brazil, India, Indonesia, and South Africa. The biggest concern is the large current account deficit (reaching as much as 7.5 percent of the GDP by the end of November 2013) that is being financed mostly by short-term volatile capital inflows. The boom in the net private capital inflows after 2008 is clear. Between 2002 and 2013 Turkey received a total of 467 billion dollars net private capital inflow.

Figure1: Net private capital inflows, 2002-2013 (million USD)

Source: Central Bank of Republic of Turkey Data Delivery System

Figure 2: Total bank credit to private sector as a percentage of GDP

Source: Central Bank of Republic of Turkey Data Delivery System

As capital inflows reached record levels, total bank credit to the private sector as a percentage of GDP has increased from around 10 percent in 2002 to more than 50 percent by the end of 2012. Expansion of credit has been one of the main drivers of economic performance in this era.

However, starting right after the Fed’s announcement in May 2013, the Turkish lira began losing its value. The mass uprisings at the end of May and the explosion of the corruption scandal in mid-December only helped increase the political uncertainty. From May to the beginning of this week, the lira lost about 30 percent of its value, forcing the Central Bank, which so far has been resistant to increasing interest rates, to sharply increase interest rates at midnight after an emergency meeting on January 28.

What is next? While the Central Bank’s sharp interest rate hike has, at least for now, stopped the free fall of the lira, the future does not seem very rosy given the fragilities of the economy. Foreign investors have about $54 billion in shares and about $50 billion in government bonds. Whether they will cut their losses (mostly due to exchange rate movement) and leave, we will have to wait and see. Unless private capital restarts flowing into the Turkish economy in massive amounts and appreciates the currency, here is what the country can expect:

First, the depreciation of the lira will create serious problems for the firms that have borrowed in foreign currencies. Short-term external debt stock is close to $130 billion. Of this, $91 billion belongs to the banking sector and $35 billion to the nonfinancial corporate sector. Worse yet, the difference between the nonfinancial corporate sector’s foreign currency liabilities and assets reached $165 billion by the end of October 2013. This is likely to lead to, at the very least, payment problems; and most probably to many bankruptcies—especially for firms that have borrowed in foreign currency but have earnings predominantly in liras. There is also news of bankruptcies due to involvement in derivative and options products.

Second, banks have begun tightening credit conditions. A slowdown in credit due to this and to higher interest rates will directly reduce demand and is likely to hit the booming construction and housing sectors. Some of the banks might also get hit by the interest rate hike due to duration mismatches.

Third, the depreciation of the lira will have pass-through effects and lead to an increase in the overall price level, especially through its effect on energy prices. The Central Bank has already revised its inflation expectations upwards.

Fourth, the depreciation is unlikely to create a significant increase in exports as Turkish exports include a high-degree of imported content.

In short, the third wave of the global crisis now hits Turkey together with other DEEs. The year 2014 is likely to see the Turkish economy experiencing stagflation as economic growth slows down, prices increase, and large masses are impoverished.

Özgür Orhangazi is associate professor of economics at Kadir Has University in Istanbul. He is the author of Financialization and the U.S. Economy (2008) and numerous articles and book chapters on financialization, financial crises, and alternative economic policies. He holds a Ph.D. from the University of Massachusetts Amherst (2006) and previously taught economics at Roosevelt University in Chicago (2006-2011).