Winter is Coming—for Turkey #TurkeyEconomy
In the last few days, Capital Economics and IIF- using different methods– heralded a recession in Turkish economy.
While data revealed the first clues only in August batch, that ship had sailed long time ago. The first and most immediate question is whether Turkey can avert a balance of payments crisis. I believe it can and focus on the aftermath.
Winter has come to Turkey, a country where genuine, orthodox and comprehensive reform or policy change is not possible as long Erdogan and AKP hold the levers of power. Turkey is facing a Greece-light episode, where for many years to come real disposable incomes will decline and corporates will go bust one after another.
Why Turkey will avert a Balance of Payments crisis?
August data headlined by a near 10% drop in composite Economic Confidence Index and the complete secession of new loans by private banks is sufficient to prove that recession is here. While many reasons can be advanced for its advent, it is the eruption of conflict with US which catalyzed previous mistakes into a witch’s brew of instable currency, rising rates and panicky policy response. Until Turkey and US kiss and make up, the threat of a balance of payments (BoP) crisis by the way of US imposing sanctions on Turkish financial institutions and thus shutting them off from the global credit markets will be swinging over our heads like proverbial Sword of Damocles.
According to the calculations of our research team, Turkish banks have liquid asset to cover roughly 4 months of F/X debt amortizations and expected current account deficits, after which CBRT runs reserves and Turkey closes the door on free capital flows.
Please do blame me for having too much faith in the goodness of human nature, but I firmly believe that when Erdogan realizes that his quest for alternatives to traditional loan and bond financing is futile, he will surrender to US demands.
Unlike many pundits, I don’t view Erdogan as a “bitter ender” who will drag his nation into poverty in a Don Quixotic battle against the US. The problem is that he is encouraged by the likes of Qatar, Russia, Iran and more recently EU to think that Turkey can tap alternative financing channels to resist US demands forever without jeopardizing economic growth or financial stability.
I’ll give him until American mid-term elections to change his erroneous views, after which I’ll become more pessimistic. US elections are critical to AKP’s thinking because it believes once these are out of the way, the pressure from the White House to release American detainees will fade, while other demands such as the abrogation of the treaty to purchase S-400 systems with Russia and compliance with Iran sanctions can be negotiated from a position of strength. This is a dream. All of these requests are American, rather than Trump policy and the pressure on Turkey will not subside until it delivers.
What is next?
Assuming I’m correct, once Erdogan surrenders to American demands, he will wait for March local elections to pass and then invite IMF for financial aid. Already, EU is approached to rekindle accession and to provide an anchor for structural reforms via its famous “chapters of the acquis”.
IMF’s prior conditions (entailing very tight monetary and fiscal policy) and the severity of the damage to corporate balance sheets means Turkey will spend 2019 in recession. However, this scenario calls for a rapid growth recovery in 2020 and onwards, driven by the inherent dynamism of the economy.
This won’t happen, because while Erdogan and AKP may be flexible enough to bend in the face of unsurmountable odds, they are certainly not mentally suited to adopt democracy, rule-based governance or structural reforms as you, I or World Bank defines them.
After the winter of 2019, a long period of sub-3% growth and social unrest will become Turkey’s fate. This episode may last until the next scheduled elections when Erdogan may lose power, or last indefinitely, as is happening in Russia, where Putin is the undeclared czar.
Why no strong recovery?
Turkey shone a brief moment in 21st Century, as pressed by fear of secularists, EU and the threat of economic demise Erdogan played the good democrat, building institutions, upgrading democratic norms and allowing the Babacan-Simsek duo to pursue reasonable economic policies.
Then came QE, which introduced the moral hazard of bad behavior to Ankara, which was followed by the Gezi Uprising and the Gulen-inspired coup of 2016 which led Erdogan to the conclusion that neither the public, nor his closest allies can be trusted. Assuming all the power was the only way to deliver Turkey prosperity.
The growth spurt recently “noticed” by the official stats agency Turkstat in 2011-2107 was accompanied by an unprecedented destruction of institutions key to stable economic growth. These are the judiciary, the free press and independent regulatory bodies led by CBRT.
Erdogan will never relinquish control of these institutions, neither will any of Turkey’s allies or IMF asks him to do so. Without institutional restoration fast growth is impossible.
Secondly, the a.m. episode also witnessed a very sharp decline in the national savings rate and a funneling of existing savings, along with foreign funds into the construction and housing sector which are very low economic return areas.
It will take years to build up liquid capital to deploy into the exporting, high-tech and productive industries of the economy.
Finally, Turkey’s already poor human capital was ruthlessly destroyed by the post-coup purge of Gulenists which rapidly morphed into a shameless witch-hunt of all opposition figures. Turkey lost its liberal capitalists, its academics, its software designers, and even its college students to the crack-down. There are very few people left to carry the economy into the Age of Industry 4.0.
Fast and sustainable growth requires inclusive institutions, plenty of capital and a human resource base which can be employed in the ever changing tapestry of a dynamic economy. Turkey has none of these ingredients and I can’t foresee a scenario under which Erdogan will allow them to flourish while he is in power.
Winter has come to Turkey. It will probably turn into an Ice Age.
Originally published in http://www.paraanaliz.com/intelligence/winter-coming-turkey/