Credit Guarantee Fund to boost Turkish growth again in 2018

The invasion of Afrin in northern Syria has dominated the agenda in Turkey these past few days. While the language of warmongering is on the rise domestically, violence is certainly not something to celebrate. The Afrin assault is also hurting the democratic environment in Turkey, with the administration’s police-state instincts sharpening because part of Turkish society questions the aggression.        

Focusing on the economy, the initial impact of the war appears limited. The lira is bearing most of the burden. The expectation is that the duration of the invasion will be limited after Turkey gained a green light from Moscow, which expects that the attack will drive Syria’s Kurds closer to the regime. Concern about Turkey’s already-sour relations with the United States, which is training and arming the Kurds to help defeat Islamic State (ISIS), is expected to increase as time passes. 

With the Afrin assault taking shape, Deputy Prime Minister Mehmet Şimşek announced that the impact of the hostilities on Turkey’s strongly-growing economy would be limited. This brings to the fore the government’s back-up plan to keep growth strong; namely expanding the credit guarantee fund (CGF) scheme.

It was no coincidence that Şimsek announced the plans at a signing ceremony between the Treasury and the CGF. The fund, which kickstarted last year, is being extended into 2018 with an injection of 55 billion liras ($15.5 billion) of fresh capital. Simsek said that 25 billion liras of that amount would guarantee bank loans for industrial companies, with 15 billion liras more for exporters.

The same day, Cemil Ertem, President Recep Tayyip Erdogan’s chief economic advisor, revealed more details of how the government would make use of the scheme. His comments, published by the English language Daily Sabah last week, provided big clues about future policy and what the government has in store for Turkey’s economy.

...the CGF has not been support established just on Treasury bail and it has never been a populist operation. On the contrary, the representatives of monetarist theories who have opposed the CGF practice and who receive their knowledge of economics from the practices of Ponzi scheme-style financial institutions have convinced us for years that palliative financial tricks and austerity policies were reforms set to delay crises. These fallacies, however, have always brought us larger crises. The CGF has broken all such clichés… By introducing the CGF, the rapid rise in inflation stopped. 2018 will be a beginning year in which the U.S. and the EU's current political and economic crisis will intensify and developing countries will start to rise politically and economically. This whole picture offers golden opportunities for Turkey. Certainly, Turkey will see quite different approaches toward key issues such as growth, inflation and unemployment like the CGF.

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As of the beginning of the year, lending by the banking sector has grown 17.6 percent annually, easing back from a peak of 20 percent in 2017. The share of non-performing loans in total loans remains stable at about 3.1 percent, according to data provided by banks. On the other hand, annual deposit growth is significantly weaker at 13.9 percent. And, as the lira weakened, deposits held in foreign currency continue to expand at an increasing rate and now total $160.6 billion. With this financial backdrop, banks are running out of resources to finance lending at the pace desired by the government. Hence the extra funds added to the CGF.  

The fund is a financial instrument that backs loans awarded to industry by banks by providing collateral. Such schemes, through which the government has provided financial guarantees for certain projects or sectors, date back to 1993. But the use of government money to reinforce economic growth through direct lending to both SMEs and non-SMEs has grown exponentially since last year.

The CGF is backed by the Treasury and had provided some 201 billion liras ($58.4 billion) as of September 2017. Including capital lent by banks, the total financial support has reached 179 billion liras. Among more than 310,000 enterprises that made use of CGF-supported loans, 75 percent were SMEs. A further breakdown shows that 56 percent of the total capital was used for new lending and 30 percent to top up existing loans. The refinancing ratio was 4.5 percent.

Thanks also to temporary tax cuts and tax amnesties, economic growth is expected to have totaled 7 percent last year, with the CGF contributing about two percentage points. Yet, the side effect of more intense economic activity and exchange rate pass-through is the current account deficit, which has widened to 5.5 percent of GDP, and double-digit inflation of around 12 percent.


With the renewal of the protocol between the Treasury and the CGF, initially signed in March last year, the fund will remain dedicated to widening the scope of the collateral that allows enterprises not categorized as SMEs or non-SMEs to take advantage of the financing.

Ertem often emphasizes that the CGF should not be seen as a cyclical tool to offset an economic slowdown. In fact, he says, government considers the CGF to be the most important structural reform it has delivered in the past few years. It is seen as permanent and comparable to the Korea Credit Guarantee Fund (KODIT), run by South Korea. As the guarantor repays some or the entire loan to a bank in the case that a borrower defaults, the government believes that the risk to financial intermediaries is reduced, thereby enabling the economy to grow faster. Unsurprisingly, Ertem is calling on banks to increase the flow of corporate credits to more than 22 percent annually so that the government can exceed its 5.5 percent economic growth target for 2018 and fight unemployment.   

The government’s disregard for the effects of very strong growth on inflation is really quite amazing. Ertem argues that the Turkish economy “does not have perfect competition or full employment making the relationship between the money supply and the general level of prices detached”. Thus, he believes both quantity theory and Friedmanian monetarism are invalid, justifying the president’s theory that high interest rates create inflation.

While it has become quite draining to argue about the inflation-growth-interest rate relationship, we should acknowledge that the CGF is here to stay.  Ertem already announced that continuing with the CGF by introducing certain benchmarks and parameters; or perhaps eliminating the Treasury back-up entirely, would give the fund an institutional character, therefore making it an intrinsic part of financial stability. In fact, Ertem goes on to argue that the rather idle SME A.Ş, owned by the state, could be used in a similar way to the previously-idle CGF; to provide financial support for SME’s. 

So, best practices will now gain in importance. The trick here is to encourage sound credit transactions through the efficient management and use of credit information and a sound ratings system for companies. Regulators can improve the CGF by establishing minimum capital requirements, appropriate solvency ratios and introduce transparency criteria in order to strengthen confidence in the scheme. 

The OECD advises that since credit guarantee scheme regulation contributes to credibility, independent regulators such as the central bank should take over the task of oversight. To reduce default and diversify risks, risk management mechanisms such as reinsurance, loan sales or portfolio securitizations should be plugged in as well.

It is quite obvious that the AKP will keep on using the CGF as a major tool to stimulate growth and keep the Turkish economy afloat. Since Ertem and the remaining advisers of the President reject that the CGF is producing negative side effects such as inflation and are urging banks to reduce interest rates; it is a fact that high inflation is here to stay. Unless, of course, the government comes up with a new detailed and credible industrial policy that cares both for industrial efficiency and technological advancement.