Turkey is struggling to support the ailing lira, which has
lost more than 40% of its value over the past two years, and with foreign
currency reserves running low, investors are trying to map out Ankara’s options
for turning the tide.
The $850 billion economy’s potential needs are huge. Were Turkey to descend into a full-blown crisis where it was shut out of international borrowing markets, analysts estimate Ankara would have to find between $40 billion and $90 billion to avoid some kind of sovereign default.
For many economists, this is a textbook emerging market currency crisis.
Years of foreign debt accumulation and rising balance of payments gaps meet a sudden evaporation of domestic and investor confidence that sends the currency sliding, inflation soaring and forces central bank interest rates higher to control it.
The interest rate and currency shocks in turn trigger a deep recession and problems in the banking system as firms and households struggle to pay back their loans — making high interest rates unsustainable and leaving the currency vulnerable to further weakness.
If foreign investment grinds to a halt and hard cash buffers disappear, Turkey has only limited options without simply building large current account surpluses that may require a much deeper and longer domestic recession.
Following are some scenarios that foreign investors see as possible.
BORROW TIME ON CAPITAL MARKETS
Ankara’s borrowing costs have shot up but it is nowhere near locked out of international capital markets yet. With a relatively comfortable debt to GDP ratio — expected to climb to around 35 percent by year-end, which is lower than most heavyweight emerging market countries — it could look to secure some cash and replenish some of its spent reserves.
The government has tapped hard-currency debt markets six times since October to the tune of $9.4 billion and has already raised 80% of the $8 billion it originally planned to borrow this year.
But it might need more and selling bonds when your economy is under severe strain can be prohibitively expensive and build up punitive repayment burdens for the future. Turkey had to pay a yield of 7.68% on a $2 billion 10-year bond tap in January — nearly twice as much as it paid a year earlier. The issue now yields more than 8%.
Debt capital markets bankers and fund managers predict Turkey would have to pay an additional 40-60 basis points for any new issues.
“If the sovereign wants to print tomorrow, they can — just at elevated levels,” said one senior banker.
Meanwhile, debt servicing costs add to the squeeze. Moody’s calculates Ankara’s interest payments rose 30.4% in nominal terms last year and almost 50% in the first quarter of 2019 due to the weak lira and a rise in payments. Interest payments are forecast to rise to around 8.2% of government revenues, up from only 5.9% in 2017.
And while borrowing on debt capital markets could help plug some holes, it won’t be enough to stop the tide if the pressure on Turkey ramps up.
Turkey could call for help from the International Monetary Fund, although President Recep Tayyip Erdogan is strongly opposed to any dealings with the lender.
Turkey has received assistance from the IMF — in varying degrees — nearly 20 times in the last 50 years and the austerity imposed under its last conditional lending program, which ended in 2008, remains a bitter memory.
But few lenders can match the IMF’s firepower, the credibility of its checks and balances and the assurance its involvement offers for overseas investors.
Moody’s managing director of sovereign risk Yves Lemay said Erdogan’s aversion to the Fund means a U-turn would not be easy or likely.
UniCredit, however, has penciled in an IMF deal being struck in the second half of the year, and BlueBay Asset Management Chief Investment Officer Mark Dowding thinks the chances of an IMF bailout are rising too.
A LITTLE HELP FROM YOUR FRIENDS
Among Gulf states — known to provide lifelines to friends in need — Ankara’s closest ally is Qatar. After Turkey’s currency crisis last summer, Qatar pledged a $15 billion package of economic projects, investments and deposits including an up to $3 billion currency swap to help support the battered lira.
Sources say talks with Doha didn’t go anywhere, however, and no public announcement of support has been forthcoming since Turkey’s most recent financial troubles began.
Two of its largest banks, Qatar National Bank and Commercial Bank, both own assets in Turkey.
Other options in the Gulf are limited. Relations with the United Arab Emirates and Saudi Arabia, both also big investors in Turkish banks, have been strained since the two Arab states launched a blockade of their Gulf neighbor, Qatar, in 2017, where Ankara supported Doha.
Some have speculated European Union countries individually or the bloc as a whole could be lending a hand, keen to contain any fallout from a Turkey crisis through close trade and banking channels. Yet European engagement on a large scale such as the Greece bailout has been linked to an IMF program, and there is little political momentum to provide money on a larger scale.
That leaves Russia and China. They are both part of the BRICS bank or New Development Bank as it is now called. But it only has $100 billion in authorized capital and is designed help develop infrastructure not help with bailouts.
No country wants to introduce capital controls but plenty do in a crisis, and Turkey has already half-flirted with the idea when the country’s local banks briefly stopped trading lira with their foreign counterparts back in March.
It has also put minor restrictions on dollar transfers and financial markets seem to be pricing for something more. Turkish banks’ price-to-book values — their share price compared to the value of their underlying assets — are nearly as low as those in Greece were when it slapped controls on during its crisis. The cost of insuring the debt of both the banks and the sovereign has meanwhile risen to such extreme levels that only serial defaulter Argentina is anywhere near.
But any such moves carry costs. If Turkey were to introduce major controls, analysts warn, it could choke off foreign investment, forcing the government to cut spending and worsening its recession.
CENTRAL BANK ACTION
Turkey could also follow the lead of Russia, which helped tame its own financial crisis in 2014 by taking a firmer grip on inflation targeting, a tool used by many major central banks.
If Turkey’s central bank were to do the same it would have to reverse course — it nudged some rates down on Tuesday — and tighten monetary policy.
But that would require something that has so far proven thorny — wresting more control from Erdogan, who has called for lower borrowing costs to boost economic activity.
“The central bank should be a key actor to rescue the country,” said Nikolay Markov, a senior economist at Pictet Asset Management. “The only way to deal with the crisis is to show commitment to fighting inflation by hiking interest rates to bring inflation down more in line with targets and contain lira depreciation.”
The lira has tumbled 12% against the dollar this year, while inflation unexpectedly slowed to 19.5% last month.
The central bank has not ruled out interest rate hikes if inflation unexpectedly jumps again but its swap rate cut on Tuesday mixes that message.