I spent the week in Turkey, visiting Istanbul and Ankara, meeting the usual mix of policy makers, diplomats, journalists, analysts, bankers and industrialists.
The worst macro mix since 2000/01 crisis.
At the outset the big picture economic take out is I think the worst I have seen since the 2000/01 crisis. With interest rates effectively taken out of the central bank toolkit, the CBRT under successive governors dating back to 2011, has been forced to macro manage the economy and the exchange rate mostly thru an overly complicated set of rules and macro prudential regulations. High inflation has been the consequence of years of these policies and overstimulation in the run up to elections – Erdogan is almost perennially in election mode. And in the run up to the last election in May, and in an attempt to use the exchange rate as a nominal anchor against inflation, the lira was artificially held more or less fixed through direct intervention and indirect moral soasion of business to limit selling pressure on the lira.
The results of all this has been to create an economic mess of distortions, resource misallocation and price and market distortions.
As the new Simsek-led economy team took office after elections, inflation was high (40% albeit half the peak of last year due to more favourable base period effects), FX reserves close to danger levels – likely intervention in recent years has topped the $200bn mark, and net international reserves are negative to the tune of something like $60bn plus. The lira was overvalued around the 20 mark to the dollar, and consequently the current account deficit wide, running at close to $50 billion on an annualised basis.
Banks were pushed to fight the government’s fight against dollarisation by a range of macro prudential measures which penalised them when the share of lira deposits fell under certain thresholds. They were forced to keep deposit rates high to attract lira deposits – over 40% – while lending rates were capped and averaged only around 17% thru the sector. Banks are currently saddled with large negative net interest margins (average cost of deposits around 26%, average lending rates around 17%), and many have just chosen not to lend as a result. Banks were also forced to buy TURKGBs as an offset for high FX deposits on their balance sheets at massively negative real rates, which appears as a time bomb in their balance sheets as rates are hiked/normalised.
The government, meanwhile, introduced an FX protected deposit scheme – where the state compensates for any FX depreciation beyond rate returns – again as a ploy to counter dedollarisarion and to compensate for the lack of the interest rate tool by the CBRT. This has been hugely popular – rising to over $100bn – but at a huge contingent and now actual cost the budget. We heard one estimate that if the lira now moves to 30 to the dollar that the fiscal cost could be $30bn, or close to 4% of GDP.
Companies are being starved of FX liquidity and credit as a result of all this. Working capital is scarce and production is suffering – industrial production has flatlined this year.
Exporters are struggling with weak demand in Europe, an overvalued lira and competiveness problems associated with big recent hikes in the minimum wage and public sector pay.
Perversely, domestic demand has been strong – partially reflecting big hikes in pensions and public sector wages, and the minimum wage before the election, but also as inflation hoarding is pervasive.
I was told that it’s almost impossible to buy a car – there are long delivery times, even though it’s impossible to get finance for more than 10% of the purchase price.
The fiscal deficit has blown out from 2-3% pa in recent years to around 9% on annualised basis earlier this year, reflective of election spending and the cost of the earthquake reconstruction. Public debt ratios remain low though at sub-40% of GDP still.
What’s the good news?
While Erdogan’s unorthodox, and just plain wrong, views on interest rates (high interest rates cause inflation) have been intrumental in creating the crisis conditions as detailed above, for whatever reason he seems to be understanding finally (again) that his policies are no longer sustainable – it’s clear from the above that without change, that Turkey is heading for a systemic crisis – BOP to banking then likely to sovereign debt. Thus, after winning the elections, against the odds, again, in May, he appointed the trusted and orthodox economist, Mehmet Simsek, as finance minister soon after the election. Simsek then seems to have been instrumental in the appointment of another orthodox thinker, Hafize Gaye Erkan, as central bank governor. Erkan’s appointment is landmark appointment for so many reasons, the first women to head the central bank, and the first with a young family. Both Simsek and Erkan are credible and clearly know the problems and can plan a route out of crisis – let’s see if they are allowed to follow this path. Simsek has a decade of policy making experience and Erkan is an acknowledged expert on banks and bank balance sheets – with the banking sector teetering on the brink she will need all these skills.
Soon after her appointment Erkan delivered a much needed 650bps hike in policy rates to 15%, and more seems to be being promised, at least reading the last MPC statement which spells out I think the need for further policy tightening.
Obviously even with the 650bps rate hike in June, policy rates remain deeply negative. The question remains as to why policy makers did not go for an immediate, much bigger hike, perhaps to 25%. Likely this reflects concern that the system is fragile, and their is concern that a larger hike could shock the system into collapse. I sense also that, given the real complexities of the macro prudential mix which they inherited, that there are not entirely clear the where shoes would fall from a shock therapy early and more aggressive hike. They clearly prefer a more gradual move to hike rates. That said, I expect a further hike in rates at the next MPC meeting in July – likely to 20%, and then further moves in August and September to take policy rates to perhaps 25-30%. Will this be enough? Time will tell, but it will be a good first move from the disastrous policy mix that they inherited.
There is still some scope to use macro prudential policies to limit demand pressures and to help the disinflation process. Credit growth is already being self constrained by banks unwillingness to lend, but something needs to be done to unblock the financial architecture to ensure credit goes to where it is most needed. At present it is not going to manufacturing.
That said, given the FX correction, post election to 26 to the dollar, inflation will remain high and sticky – the consensus is that inflation again picks up steam over the next few months, and ends the year in the 45-50% range.
The obvious fear is that the new economy team is being constrained by the obvious political timetable as local elections are due in March 2024, and Erdogan will no doubt targeting the recapture of the important cities of Ankara and Istanbul.
Fiscal policy has already been reined in aggressively over the past month or so, with aggressive tax hikes. Many of the private sector economists I met criticised the balance of overall economic policy now, arguing that fiscal policy is now too tight, and monetary policy too loose, a mix which is unlikely to do the trick in terms of reining in inflation as the pressure point will remain the lira which could continue to weaken creating significant exchange rate pass thru.
Obvioualy there was much debate over the logic of upfront monetary tightening versus a more gradual process. Simsek/Erkan seem to prefer a gradual approach – perhaps assuming that the availability of Gulf money will buy them time.
All feels very jenga like – Simsek and Erkan are trying to remove the bricks gradually to avoid a collapse, but that might still be inevitable. The shock therapy crew would perhaps argue better to just go to positive real rates ASAP and remove all the distorting macro prudential regulations ASAP, and then use Gulf or IMF money to fill the gaps, but at least all the skeletons would have been exposed. As is it’s just very difficult to identify where the next problem, or skeleton, is going to come from. History might suggest that a shock therapy would be the better option, and give the best chance of stabilising the economy this side of local elections.
The Gulf to the rescue?
The rest is here.