Mark Bentley
Jul 14 2018

Turkish crisis risk underlined by Fitch downgrade

Turkey is slipping further towards a possible financial crisis and the risks appear self-inflicted as President Recep Tayyip Erdogan tightens his grip on economic decision-making.

On Friday, Fitch Ratings became the latest foreign institution to warn Erdogan of the dangers of seizing economic control over Turkey at the expense of respected technocrats and bureaucrats. It downgraded the country’s debt rating to BB, further into junk territory, citing policy actions taken by the Turkish president since he was re-elected on June 24.

Erdogan is seeking to shape Turkey in his own image, which includes making the country one of the world’s top 10 economies by its centenary in 2023, helped by risky economic stimulus measures. The economy would need to almost triple in size to achieve that goal. He is also ratcheting up tensions with Turkey’s western allies as he attempts to wield more political and military influence in the Middle East, Balkans and Africa, aiming to restore the status Turkey had held under the Ottoman Empire more than a century ago.

This week, Erdogan unnerved investors further by saying interest rates will fall and issuing a decree giving himself the sole power to appoint the central bank governor and his deputies for a period of four years. Erdogan also appointed his son-in-law to take charge of the economy. Berat Albayrak, 40, is married to Erdogan’s daughter, Esra.

As a result, the lira slumped to a record low of 4.98 per dollar, leading a sell-off in emerging-markets. The main BIST-100 stock index in Istanbul lost more than 10 percent of its value, led by the nation’s banks, who are being forced to enter negotiaions with borrowers to restructure tens of billions of dollars in foreign currency debt that are becoming more difficult to repay as the lira tumbled. The currency has lost about 25 percent of its value this year.

"In Fitch's opinion, economic policy credibility has deteriorated in recent months, and initial policy actions following elections in June have heightened uncertainty," the ratings agency said late on Friday. “This environment will make it challenging to engineer a soft landing for the economy.”

The cabinet, overseen by the prime minister, previously chose the governor of Turkey’s central bank. But the post of prime minister is now abolished under Erdogan’s strengthened presidency, which came into effect upon his inauguration on Monday. Ministers now sit in his Presidential Cabinet. Erdogan also abolished a stipulation that deputy governors of the central bank must have a decade of experience.

Albayrak now heads the Treasury and the Finance Ministry; until now they were run separately by two ministers. He replaces figures who are highly respected by international investors; namely Mehmet Simsek, a former Merrill Lynch economist, and Naci Agbal, who was undersecretary of the finance ministry before he became minister.

Berat Albayrak
Berat Albayrak, Turkey's new minister in charge of the Treasury and Finance Ministry

Erdogan combined Simsek’s and Agbal’s former roles as part of a wider reduction in cabinet posts. He said the downsizing was needed to lift bureaucratic obstructions and speed up decision-making. He also appointed one of his closest political advisers, Mustafa Varank, as minister of industry. Varank replaces Faruk Ozlu, who was a career bureaucrat before winning a seat in parliament in 2015.

Erdogan has spurred growth in Turkey’s $880 billion economy – the expansion has averaged more than 8 percent over the past three quarters -- by focusing on construction of high-rise apartment blocks, airports, bridges and roads. He has also sought to drive the expansion with tax breaks, loan guarantees and by encouraging more consumer spending, which has fuelled imports and inflation. As a result, Turkey’s current account deficit has widened to a precarious 6.5 percent of GDP while the inflation rate has jumped to 15.4 percent, about four times the average in emerging markets, and is set to run higher in the coming months.

“He does not seem to appreciate that Turkey’s growth model requires an overhaul to join the league of rich economies,” Fadi Hakura, an associate fellow at Chatham House in London, wrote in a report this week. “It is too reliant on consumer spending and government-sponsored infrastructure and construction projects funded by speculative financial flows rather than on sustained private investment and exports.”

Turkey’s move to what Erdoğan terms “the Executive Presidency” was approved in a nationwide referendum in April 2017, marred by accusations of ballot-rigging. Thanks in part to Putinesque control of the media, Erdogan won a second term as president last month with 52 percent of the vote, seeing off his nearest challenger by more than 20 percentage points and avoiding a run-off.

Fitch is also warning the government about the amount of foreign currency that Turkish corporations are borrowing. The loans total more than $220 billion, when subtracting the foreign exchange assets that those companies hold. The slump in the lira has already contributed to the collapse of Turkey’s biggest telephone company, Turk Telekom, which was taken over by banks last week with the owner, Saudi Oger, owing almost $5 billion in unpaid loans. Yildiz Holding, the owner of Godiva chocolates, has also renegotiated a similar amount of debt with Turkish banks. Energy companies, suffering under government price caps, are said to be restructuring about $20 billion.

Hakura and Marcus Ashworth, a former chief strategist at Haitong Securities in London, both warned this week that Erdogan’s government could decide to introduce capital controls should the economic situation worsen. Ashworth pointed to comments by Erdogan this week in which he called on banks to “share the burden” to help stimulate economic growth.

Capital controls would be “a scary concept for a country with such a large and growing current account deficit that relies so heavily on overseas funding,” Ashworth said.

Erdogan is known to have taken advice on capital controls and how they might be applied in Turkey several months ago, when the chances increased that the state-run Halkbank may be fined tens of billions of dollars for helping an Iranian-Turkish businessman break sanctions on Iran, An investigation by the U.S. Treasury is ongoing.

The government has previously denied such plans. Albayrak sought to calm investors this week with two statements that reasserted the government’s commitment to the central bank’s independence and laid out the government’s plans for the economy. The lira was little moved.

The former energy minister and CEO of Calik Holding, an energy and construction company, is due to meet with investors in London as early as next week to convince them that the economy is safe in his hands, and ultimately those of his father-in law.

While Albayrak said the government would prioritise lowering inflation back into single digits – the central bank’s medium-term goal is 5 percent – and rebalancing the economy, his comments were short on detail.

And nowhere did Albayrak openly state that the government would favour an increase in interest rates by the central bank to help rein in inflation and the lira. Erdogan says higher interest rates stoke inflation, disagreeing with conventional economic theory.

Central bank policymakers are due to hold a regular meeting on interest rates on July 24, with investors expecting a substantial increase in the benchmark rate of 17.75 percent.