Is Turkey’s economy facing a ‘sudden stop’?

The Turkish government has been emphasising the strong economic growth of 7.4 per cent in 2017 with the unemployment rate dropping down to 10 per cent. However, the double-digit inflation at 10.9 per cent signals risk alerts. In 2018, the economy growth is expected to slow down to the rate of 4.7 per cent, while inflation will remain hyper at 10.4 per cent. Inflation hit a record high of 15 per cent last June with the Turkish lira declining to one fifth the US dollar value, a 60 per cent depreciation since 2015.

Like populist regimes implementing expansionary policies prior to election times, the Turkish government focused on one side of the coin by leveraging growth figures, while hiding deep serious issues. This high growth came at a cost of widening imbalances. Current account deficit stands at -5.7 per cent, while the balance of payments indicates a signal of FDI (foreign direct investment) capital outflows. Turkey’s current account deficits have been historically financed by FDI, which is not the case anymore.

While many opponents and western countries argue that Turkish President Recep Tayyip Erdogan’s political role has been alienating foreign investments, this is not the complete story as it is strictly business. The increased interest rates of the US Fedral Reserve in the last couple of years have attracted capital inflows of FDI and portfolio equity from emerging countries, particularly the Middle East, North Africa and Turkey (MENAT) region. 

Hot money is highly present in emerging economies, which have been a main factor in global imbalances and what is going on in Turkey is systemic distortions from exchange rate policy management and nature of capital flows leaving the country.

Turkey’s external debt reached $453 billion, more than half of its GDP at 53.3 per cent at the end of December 2017, $467 billion in first quarter of 2018, while their lowest was $44 billion end of 1989 at 40 per cent of GDP; for instance, the US external debt stands at 25 per cent of GDP. Like other emerging countries borrowing in foreign currency, it is a critical problem when exchange rates change. The private sector accounts for 70 per cent of Turkey’s external debt. Exchange rate depreciation of the lira has increased liabilities on Turkish businesses which have limited their borrowing. In short, Turkey’s external debt is at a state of “Liabilities Dollarisation”.

The currency mismatch and volatile capital flows in Turkey is at a structural risk with an alarming problem of reaching a moment where they cannot borrow any more. The increased interest rates in the US have caused reallocation of funds out of several emerging economies, thus structural weakness has become obvious in the MENAT region. 

Turkey might face a “sudden stop” to its economy, which is a very serious issue that consists of periods of relative calm followed by large and sudden declines in output and consumption. Equity market behaviour has been reflecting the edge of a sudden stop. Turkey’s stock market has fallen more than 20 per cent since the beginning of 2018.

To conclude, Turkey is having a problem in its balance of payments driven by deficits in current and financial accounts. Its high demand driven economy is fueled by monetary policies that put burdens on a weak lira. Liability dollarisation is leading to a sudden stop where enterprises will not be able to borrow any more. Thus, a supply side disruption would drive the economy into a stagflation state, like Brazil after the global financial crisis which would be a very sophisticated scenario.

Turkey should adapt capital controls policies, particularly to limit hot money. Foreign reserve accumulation taken by the Turkish Central Bank that covers their imports for 6 months have been declining, which indicates the selling of reserved dollars to buy domestic currency, the problem arises when reserves run out as they did in Turkey in 2000.

Turkey should make difficult decisions by entering its economy into a contractionary mode to tackle high inflation and limit capital outflows. Thus, the central bank should raise interest rates, which will have a negative effect on the aggregate demand side of the economy but would resolve its economy in the medium and long run.

The writer is chairman of Zarqa Chamber of Industry. He contributed this article to The Jordan Times