What is the scale of the Turkish economic problem?

Recently I watched a BBC Four documentary series on the House of Osman or as we call it the Ottoman Empire which extended into south-east Europe as well as around the Mediterranean into North Africa. Now we associate it with decline and the phrase “young Turks” which oddly seems to have given inspiration to Rod Stewart but back in time it was a thriving Empire managing to rule parts of the world that we now consider not only as hot-spots but maybe too hot to handle. Now we find that the subject of a possible empire is in the news yet again.

Investors have been unnerved by Mr Erdogan’s decision to place his son-in-law in charge of the economy brief while sidelining familiar and respected former ministers. ( Financial Times)

Promoting family members is something of an in thing as is some of the language used.

Berat Albayrak, who is also Mr Erdogan’s son-in-law, said the central bank would be effective “like never before” and promised to bring soaring inflation down into the single digits “in the shortest time possible”.
“Speculation about the independence and decision-making mechanisms of the central bank is unacceptable,” he added. “A central bank that is effective like never before will be one of the fundamental aims of the policies of the new era.”

He failed however to use the trump card of a “bigly”. Of course the Financial Times somehow still manages to believe in central bank independence whereas we abandoned such thoughts years ago. Whilst the example below is admittedly extreme the theme is familiar.

Turkey’s central bank announced three interest rate rises during the campaign for June 24 elections, with a cumulative total of 500 basis points. The bank’s benchmark lending rate stands at 17.75 per cent.

So up,up and indeed up and away whereas the rhetoric is rather different. This is Hurriyet Daily News quoting President Erdogan on the 11th of May

“My belief is that interest rates are the mother of all evils. Interest rates are the cause of inflation. Inflation is a result, not a cause. We need to push down interest rates,”

As we wonder if Bank of England Governor Mark Carney was taking notes it is time to switch to the economic impact of all of this. The first factor we have already noted which is an interest-rate of 17.75% which is out of kilter with the economic times by some distance. As opposed to the -0.4% of neighbouring Greece or the 0.1% of Israel if we look the other way. So a break is being applied.

The Exchange-Rate

We can switch quickly to this as we know we only get rises in interest-rates like this if the national currency is in what Taylor Swift would call “trouble,trouble,trouble”. The latest Central Bank of Turkey minutes puts it somewhat euphemistically.

exchange rate developments

Or as the Hurriyet Daily News puts it.

The lira weakened to a record low of 4.9767 against the dollar late on July 11. The currency opened the July 12 trading at around 4.83 against the greenback.

The lira has shed nearly 25 percent of its value against the U.S. currency so far this year.

If we look at the pattern we see that the rate has been heading south for some time as five years ago it was at 2.04. However an acceleration started at the end of April when it was 4.05. Or returning to Ms Swift.

And the haters gonna hate, hate, hate, hate, hate

If we stay with financial markets there is a familiar sequence of responses to this.

Fall-out from Turkey’s tumbling lira hammered banking shares on July 11, sending the Istanbul stock market to its biggest one-day fall in two years.

The main share index dropped more than 5 percent while bank stocks lost 9 percent in their worst day for five years.

The yield on Turkey’s benchmark 10-year bond rose to 18.48 percent from 17.36 percent at close on July 10.

Central bankers will be panicking at all the negative wealth effects here. Care is needed as in such volatile circumstances markets ebb and flow quickly although it has mainly been ebb. Also the official interest-rate and bond yield numbers remind me of my analysis of how to deal with a foreign exchange crisis on May 3rd. If you think that a currency is collapsing then even ~18% interest-rates do not help much and even worse via forward or futures calculations it makes it look like the currency will drop even further. At some point investors will think things have stabilised and especially in these times will pile in for a juicy yield but when?

I’ll never miss a beat, I’m lightning on my feet

The trouble is that in the meantime you have slammed the brakes on your domestic economy.

Inflation

This is a consequence of the lower currency as the price of imported goods and services rises. For a while existing contracts may be a shelter but then it hits home.

In May, consumer prices rose by 1.62 percent and annual inflation increased by 1.30 points to 12.15 percent. The uptick in inflation spread across subgroups in this period ( CBRT)

Last week we learned that the CBRT was right to expect more bad news.

Inflation rose to 15.39 percent year-on-year, the highest annual rate since 2004 after a new method of calculating price rises was introduced, and month-on-month CPI inflation leapt to 2.61 percent – nearly double the forecast in a Reuters poll.

It looks set to go higher still.

Trade

Whilst a lower currency boosts an economy as price competitive exports and imports respond this takes time. Before they do you are actually in a worse situation as your imports cost more as the J-Curve and Reverse J-Curve entwine. Thus we get this.

According to the data released on July 11, the current account deficit rose to $5.9 billion in May from $5.4 billion in the corresponding month last year, with a nearly 9.6 percent year-on-year increase. ( Hurriyet Daily News)…….The country’s 12-month rolling deficit reached $57.6 billion in May, the data also showed.

This compares to these.

Turkey’s annual current account deficit in 2017 was around $47.3 billion, compared to the previous year’s figure of $33.1 billion.

Comment

Much of this feels like the UK in the 1970s although to be fair Turkish inflation it has yet to hit the 26.9% seen in the summer of 1975. A sharp brake has been applied to the economy via the higher cost of imports and via higher interest-rates. If we move to the business sector there will also be an impact from this.

The Turkish energy sector is facing an increasingly unstable situation with a rapidly declining lira making it impossible to repay billions of dollars’ worth of loans accumulated over the past 15 years.

Since 2003 $95bn has been invested into the country’s energy sector, of which $51bn remains to be paid. This figure represents 15% of the $340bn owed by non-financial companies in overseas liabilities, according to data from the nation’s central bank. ( Power Technology)

This is also familiar as countries which are in danger of trouble make it worse by borrowing in a foreign currency because it is cheaper in interest-rate terms. After all what could go wrong? It is also reminiscent of the foreign currency mortgage crisis of parts of south-eastern Europe. At least they did not borrow in Swiss Francs.

A recession is a danger as this hits and we will have to wait and see what develops but as to the talk of plenty of measures that sounds a little like capital controls to me. However the official view echoes Ms. Swift again.

I shake it off, I shake it off
I shake it off, I shake it off

 

 

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12 thoughts on “What is the scale of the Turkish economic problem?

  1. Yesterday I pointed out low interest rates should mean low inflation but this topic again highlights the high inflation we had in the 70’s and high interest rates!

    I appreciate one cannot compare the UK economy to Turkey, each economy has its own way of how it develops, so the outcome can never be predicted accurately.

    I read somewhere not many moons ago the Ottoman empire the richest in the world at one time, how things have changed.

    History cannot be relied upon to predict the future, the fact that numerous governments and leaders have implemented measures to prevent assets falls does not guarantee this will not happen!

    • Hi Peter

      Yes the Ottoman Empire was at its peak very different to what it was like towards the end. As to wealth they were in control of quite a bit of the silk road as well as quite a bit of the Mediterranean. Much much less of that these days as China has now plenty of alternatives.

  2. Turkey does have however, 547 ttonnes of gold, as opposed to our 310 tonnes, Gordon Brown famously sold off 395 tonnes and told the market he was doing so beforehand, just to ensure the worst possible price, to ensure a certain bank didn’t loses billions when it was in a massive short squeeze on its speculative gold position. The long term interests of the country were tossed aside for a foreign bank, and he was allowed to get away with it.

  3. Hello Shaun

    “Fall-out from Turkey’s tumbling lira hammered banking shares ….”

    German and French Banks I presume – so unfortunate that Turkey is not in the Euro as the ECB will need to find another way ti bail out those TBTF banks!

    and

    a failing currency re balances the economy , so why the fuss ? seems the BoE thinks its ok for us ? umm ?

    Forbin

  4. Instructive to compare the growth and unemployment rates in Turkey vs Greece. Are you show that low inflation is a good idea?

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