Mustafa Sönmez

Ankara is increasingly focusing on managing its economic crisis, which despite its slow pace is now being acknowledged by the authorities. Political tensions with the United States abruptly plunged the Turkish lira to record lows of more than seven against the dollar in August, overheating the economic climate. The relative easing of bilateral tensions since then have helped the lira regain ground, with the price of the greenback decreasing to about 5.2 liras in late November. The decrease, however, was the result also of economic contraction, which led to imports falling to $16 billion in October, a $5 billion decrease from four months earlier. The contracting economy means a lower demand for foreign exchange. Increased interest rates on the Turkish lira have also been instrumental, encouraging deposit holders to shift from foreign exchange to liras.

Yet the relative decrease in foreign exchange prices does not mean the crisis is over. On Dec. 4, the lira began sliding anew amid investor concerns over early loosening in monetary policy. Also, interest rates on the lira have significantly risen over the past several months and inflation remains over 20%, while the unemployment rate has exceeded 11% and is likely to increase further. Industrial production is on the decline, with figures from the construction sector indicating a significant downtick in what used to be the driving force of Turkey’s economic growth.

With local elections looming on March 31, the ruling Justice and Development Party is wary of being punishing by angry voters, so the government is scrambling to ease the impact of the crisis. Some of the measures, however, miss the goal of reining in inflation. A tight fiscal policy, for example, has been set as a target, along with a tight monetary policy, but the government has taken steps that water down the fiscal policy such as tax reductions, exemptions, remissions and increased spending in some realms.

It remains to be seen what stance Ankara will adopt in the coming weeks on the minimum wage and salaries. In the meantime, it has been outlining measures to ease the pressure on banks, which, prompted by the government, have opened up loan channels to companies struggling to adapt to the crisis climate. Efforts on this front have included some irregular steps such as the use of the Unemployment Insurance Fund outside its purpose.

The banking sector is among the hardest hit from the crisis. The turmoil here is “homemade,” stemming largely from the failure of real-sector companies to roll over external debts. The crisis in the real sector has had an immediate effect on its financiers in the banking system. Many Turkish banks — downgraded several times by international credit rating agencies this year — are in need of restructuring.

Public banks, in particular, are known to have serious balance-sheet problems as a result of heeding commands by President Recep Tayyip Erdogan. Ziraat Bank, whose original purpose was to finance agriculture, and Halkbank, which was founded to support small producers, were made the financiers of Istanbul’s new airport, one of Erdogan’s pet projects. Ziraat Bank is known to have extended loan support to the pro-government Demiroren business group in its acquisition earlier this year of the Dogan Media Group in the country’s biggest media handover. Halkbank, meanwhile, has been embroiled in a gold-trading scheme that helped Iran to evade US sanctions.

Monthly risk analysis reports by the Banks Association of Turkey suggest that loan repayments are not yet a problem. As of September, delayed loan payments amounted to $570 million, or 3.3%, out of some $18 billion in issued loans. This may not be an alarming figure, but with a bit broader definition of non-performing loans, the picture gets gloomier.

Overdue loan payments under close monitoring but not yet subject to legal action are in what is called Group 2. Together with the officially delayed payments above, they amount to between 17% and 18% of the total. A report by bankers Ovunc Gursoy and Mete Yuksel on six publicly traded banks puts the amount of their problem loans, including Group 2, at 17%. Denizbank director-general Hakan Ates said Dec. 2 that problem loans in the broader sense, including delayed payments and Group 2, make about 17-18% of the total.

Also, the capital structure of banks, especially public ones, has weakened. In a first step to address this problem in September, Halkbank and Vakifbank issued 5 billion-lira ($1 billion) subordinated bonds each, to be sold to qualified investors. Soon, it emerged that the Unemployment Insurance Fund was made to buy the bonds, even though the move did not comply with established rules.

Then, in late November, it was announced that Ziraat, Vakifbank and Halkbank had formed a mortgage loans pool to use as collateral to issue mortgage-backed securities.

Meanwhile, the legal status of the state-owned Development Bank was amended in October. It was already known that the bank would be tapped to handle the non-performing loans of other banks. In this operation, the Development Bank was tasked with issuing asset-backed securities worth 3.1 billion liras (some $600 million) and swapping those lira-denominated five-year bonds that have yields of 18.5% with the bonds of the public banks.

Normally, banks would sell such asset-backed securities to funds seeking guaranteed profits. But will the funds put money in such bonds under the current conditions? In an economic environment where inflation is running at more than 20%, the asset-backed securities are not expected to attract much interest.

If banks fail to sell the treasury-guaranteed asset-backed securities, could they use them as collateral to borrow from the Central Bank? The Banks Association reported last week that “liquidity provision by the Central Bank with regard to the [bond] issuances had not been under consideration,” but few seemed convinced by the statement.

It is widely expected that the Central Bank will be forced to accept the asset-backed securities as repo collateral at the expense of monetary expansion. If this anticipation materializes, Ankara’s claim of following a tight monetary policy will largely lose its credibility, especially in the eyes of foreign financiers. This, in turn, would add another stumbling block for Turkey’s efforts to attract much-needed foreign funds to overcome its economic troubles.

The stable economic growth that Turkey has experienced since 2001 has come to an end. The growth began after the financial crisis in 2001, when an International Monetary Fund program was implemented to address that crisis. Then, in 2002, the Justice and Development Party (AKP) came to power, kicking off a period of long-term growth. From 2003-2008, Turkey registered an annual growth of 5.9%. From 2009-2017, the rate of growth was 4.9% a year.

This period of economic growth created more disposable income and jobs. It also led to an increase in taxes and therefore public services, giving the AKP a steady base of voters. As a result of this economic performance, the AKP was able to build the political Islam regime it had aspired to.

The most important feature of the “good life” in Turkey was the country’s access to an unprecedented amount of foreign resources. A stable internal environment combined with easily accessible global liquidity provided Turkey with abundant foreign resources. The expansionist monetary policies of the United States and the EU to manage the global financial crisis enabled countries like Turkey to obtain foreign resources and endowed Turkey with a rate of about 5% stable growth.

But after 2014, there were signs that the good life may be coming to an end. External expansionist policies were nearing an end and interest rates were set to increase. Turkey was able to prolong its period of growth until the end of 2017, but it couldn’t fend off the 2018 crisis. According to the Central Bank of Turkey’s balance of payments figures, in the first nine months of 2018 there were no resources available from abroad, while $4.2 billion of foreign resources departed Turkey.

In the growth period, about one-fourth of foreign resources were used as household credits. After 2003, the Turkish public grew used to living off credit like never before. Consumer credit in the form of housing and car loans rapidly spread. The use of credit cards also became routine.

Consumer loans helped keep domestic demand alive, but it also caused massive debts for low-income families who had mortgaged their financial futures.

In 2004, easily available consumer credit and borrowing on credit cards constituted 4.6% of the annual national income, which was 24% of total bank credits. Households were encouraged to seek attractive long-term housing loans and to fill their wallets with easy installment offers of lucrative bank and credit card deals that promised easy paybacks. Household debts that were 4.6% of the annual national income in 2004 climbed to 18% of the national income by 2013, making up 31% of total bank credits.

After 2014, household debts began to broadcast serious warning signs, as banks were not able to collect on the loans. The AKP regime realized it had to impose some restrictions and insurance rates went up. Until 2017, growth based on domestic demand was the most prominent leverage of the system. It enabled about 19 million unorganized, non-unionized workers to live on loans. According to the Confederation of Revolutionary Labor Unions, or DISK, 66% of workers were earning below $365 a month. Since it would be practically impossible to survive on that income, it was obvious that households were adding to their incomes with easily available credit.

This way of balancing the family budget became more difficult in mid-2018. Consumer inflation was amplified by a rapid increase in foreign currency parity and abnormal tensions with the United States. It became imperative to increase Turkish currency interests, thus further increasing consumer credit and credit card borrowing. The interest rate for housing loans went from 13% in the first quarter of 2018 to 29% in November. More importantly, more households were taking out bank loans to pay credit card debts, with interest rates reaching 37%. According to the Financial Stability Report issued by the central bank in May 2018, bank debts and credit card borrowing had reached about $153 billion, making up 56% of household debts.

Turkey’s low and middle income laborers, white collar workers and retirees were severely pressed in paying back their debts. Facing serious delinquencies in paying back the household credits, many debtors began facing legal actions because of their arrears. According to data issued by the Union of Banks of Turkey, 1.1 million people faced legal action in 2017. In the first nine months of 2018, this figure reached over 3.2 million debtors. Banks could not collect about $3.5 billion, or 21% of the debts.

Banks are still concerned they won’t be able to collect on the loans. Some of the debtors may lose their jobs. Those who keep their jobs may not make enough money to cope with the 25% inflation.

In a nutshell, this could mean millions of families will struggle to pay back loans. Banks, meanwhile, will face growing risk in collecting loans all the while reducing domestic demand for them and thus prolonging the current crisis.

Turkey’s consumer inflation overshot expectations in October, climbing 2.67% and bringing year-on-year inflation to 25.2%, much to the chagrin of Treasury and Finance Minister Berat Albayrak, the president’s son-in-law, who had declared an “all-out fight against inflation” in mid-September.

The details of the inflation data, released Nov. 5, show that food prices shot up nearly 30% from October last year. In the subcategory of fresh fruits and vegetables, the increase was even more staggering, hitting 50%.

For Turkey, such inflation is unprecedented since 2004. The sharp increases in food prices hit low-income groups especially hard, as they spend a significant part of their budget on food. According to official statistics for 2017, the largest item in household spending was housing and rent at 24.7% of total spending, followed by food at 19.7%. The lower the income, the larger the share spent on food. Impoverished households in the bottom 20% on the income scale spent 29% of their budgets on food.

Coupled with economic contraction and increasing unemployment, the surging inflation owes much to a structural setback, namely an insufficient supply in agricultural products or a food deficit. The concerned authorities, including the Central Bank, agree that Turkey will struggle to get rid of double-digit inflation unless these problems are resolved.

In its inflation report for the third quarter, the Central Bank said, “Occasional supply shortages in unprocessed food products in Turkey that lead to sudden and sharp price increases mainly stem from structural factors. Here, the inability to make an efficient and dynamic agricultural production plan is considered to be a significant structural problem. Developing a production plan requires strengthening of agricultural statistics, yield estimation and early warning system infrastructure.”

Yet the Central Bank failed to delve further into the core of the problem, focusing instead on the role of middlemen. “Another structural problem causing cyclical supply shortages is the mismanagement of the field-greenhouse-field transition, particularly in fresh vegetable products,” the report says. “Despite being short-lived, these transitions lead to supply shortages and enable the intermediaries who dominate the market to speculate on prices and achieve excessive gains.”

No doubt, speculative profits by middlemen should be prevented, but the primary problem that needs to be highlighted is that the agricultural sector is losing producers and its share in the gross domestic product is rapidly falling. Agriculture accounted for 6% of GDP in 2017, down from 10% in 1998.

In recent years, Turkey has become a net importer of food despite its abundant agricultural potential and recent classification as self-sufficient and safe from food security risks. In the 2016-2017 market term, for instance, the rate of domestic output meeting domestic demand in cereal products was 97.2%. In other words, the locally produced crops such as lentils, chickpeas, haricots, barley and sunflower were not enough to meet domestic demand.

The factors behind the decline of Turkish agriculture can be traced back to ill-advised policies in the 1980s and 1990s. Public enterprises that significantly propped up the sector prior to 1980 were privatized on the grounds they were a burden on the treasury. Similarly, subsidies were reduced on the grounds that agricultural support purchases contributed to central budget deficits. An agriculture law adopted in April 2006 appeared to legally guarantee support to farmers, but that was not the case on the ground. According to the law, funds of at least 1% of GDP must be allocated to supporting farmers, but according to Turkey’s Agricultural Chambers Union, the amount of support has remained at only 0.56% of GDP.

The decreased support condemned agricultural output to trail behind industry, which in turn meant that agriculture ceased to be a source of livelihood for a significant portion of the populace. In 2000, Turkey’s agricultural sector employed 7.7 million people, or nearly 36% of an overall 21.5 million people. In 2018, the overall figure was up at 29.2 million people, but the share of agriculture was down at 19.5%. The number of people employed in agriculturehas decreased by 2 million to 5.7 million in 17 years.

Farmers have been grappling with high input costs to sustain production. They often take losses, unable to sell at prices justifying the production cost, driving them to quit the sector.

The decline in agricultural activity and the aging population in rural areas have left vast farmlands uncultivated. Many agricultural fields in proximity to urban centers have become plots for housing projects and commercial buildings. According to data by the Turkish Statistical Institute, the country’s farmlands shrank to 38 million hectares in 2017 from 41 million in 2001, a remarkable 7.3% shrinkage. That only a third of the fields enjoy access to irrigation is another important problem of the sector.

Last but not least, Turkish farmers rely heavily on imported inputs both in crop cultivation and husbandry, another factor that drives them away from the sector. On the crop side, this reliance includes basic materials such as diesel fuel, fertilizers, seeds and pesticides. And because of the depreciation of the Turkish lira, the cost of imports keeps rising, coupled with hefty taxes.

In husbandry, many inputs are also import-reliant, including breeding animals for dairy farming and stocks bred for meat. Amid shrinking pasture areas, the sector has largely adopted manufactured fodder, and more than 50% of those raw materials are also imported. Even in the production of barley and corn, two key inputs for the fodder industry, the self-sufficiency rates have fallen to 89% and 88%, respectively.

In sum, agricultural and trade policies over the years have served to boost imports rather than agricultural output. As a result, the supply deficits in agricultural products and food have increased and so have their prices. Unless structural problems are resolved, Turkey’s food inflation is clearly bound to continue.

Turkey’s construction sector, the backbone of Ankara’s growth policies for the past decade and half, stands out among the earliest victims of the country’s economic crisis, rapidly contracting and threatening to drag others down with it.

The sector, including realty, accounted for 15.7% of Turkey’s $851.5 billion in gross domestic product (GDP) last year, almost on par with the manufacturing sector, which accounted for 18.5% of GDP. After impressive expansion, sales are now shrinking rapidly for homes and offices, leaving builders with swelling stocks. Housing demand, in particular, has fallen sharply, hit by the slump of the Turkish lira and the ensuing increase in interest rates. Building companies are struggling to decrease stocks and repay bank loans. Despite government incentives, including tax cuts and cheaper loan campaigns, the sector remains in turmoil, and the circle appears to be tightening.

In the first nine months of the year, home sales decreased 2.7% compared to the same period last year. Mortgaged home sales, meanwhile, were down 29.4%, largely the result of the increase in interest rates. The rate on home loans hit 25.2% in September, up from 12.9% in September 2017, before climbing further to 29% in October.

The overstock problem has also strained the government’s Housing Development Administration (TOKI) and its affiliated Emlak Konut, the country’s biggest real estate investment trust. Founded in 1984 to develop land with infrastructure and provide loan support to mass housing builders, TOKI turned to high-profit housing after the Justice and Development Party (AKP) came to power in 2002. Since 2008, it has also focused on the construction of public buildings, including hospitals and schools. As of June, TOKI had 142,000 homes for sale. Since 2003, it has sold about 696,000 of the nearly 838,000 homes it built, but it is now struggling to attract buyers, and the number of its new projects has visibly decreased.

Sales figures in branded projects developed by Emlak Konut also indicate a slow down. Nearly half of Emlak Konut homes, offices and shops remained for sale during the first half of 2018, according to a company activity report released on the Public Disclosure Platform.

Shrinking demand has also led to tangible drops in home prices. As a result, the annual increase in housing prices has fallen well behind the increases in overall consumer and producer prices. As of August, the 12-month increase in housing prices stood at only 3.8% in Istanbul, 8.6% in Ankara and 15.7% in Izmir, according to central bank data. Producer inflation was 32% for the same period, a striking sign of how the increase in housing prices was not even half of the inflation rate.

Hardship in selling or renting finished homes and offices has forced an abrupt halt in new investments. Another major factor is the spike in construction material prices amid the rapid increase in foreign exchange prices and interest rates over the past several months. The construction cost index by the Turkish Statistical Institute indicates that the prices of construction materials soared 44% over the last 12 months, with overall producer inflation reaching 46% in the same period. In 2016 and 2017, the increase in construction material prices stood at 13% and 27%, respectively. The soaring costs have not only discouraged new investments but have also dealt a heavy blow to ongoing projects.

A sharp downturn is seen for infrastructure as well. Public construction investments have rapidly slowed, and the so-called megaprojects, launched as public-private partnerships (PPP), have also fallen into crisis. PPP projects, including airports, highways, bridges and hospital campuses, many of them in and around Istanbul, have been hit by foreign currency losses due to the meltdown of the Turkish lira, which has aggravated the debt burden stemming from the foreign loans acquired. The increasing costs are hard to cope with for those projects as well.

Dozens of construction companies have already thrown in the towel, lining up for bankruptcy protection in commercial courts. The hardest blows, however, are being felt by the sector’s workers, from blue-collar laborers to architects and engineers. Employment figures in the sector are on a downtick. Moreover, the increase in labor coststrails well behind consumer inflation, indicating a meltdown in the real income of construction workers. As of July, the 12-month increase in labor costs stood at 17%, compared to a nearly 20% increase in consumer prices for the same period.

When the AKP come to power in early elections in November 2002, it was handed a rehabilitated economy on a silver platter, while the three outgoing coalition partners were ousted from parliament, paying the penalty for the International Monetary Fund-backed austerity measures that put the economy back on track after a severe crisis in 2001. Drawing on this precious inheritance, the AKP government was able to attract an extraordinary inflow of foreign funds, including in the aftermath of the 2008 global crisis, until 2014. Thanks to those foreign funds, obtained mostly through borrowing, it achieved high rates of economic growth, which relied largely on the domestic market and was heavily driven by construction. The government paid no mind that construction was not generating much-needed foreign exchange, enjoying the political returns of the building frenzy.

Turks were impressed by the grandiose airports, bridges and buildings springing up before their eyes, rewarding the AKP at the ballot boxes. In further electoral gains for the party, the construction boom meant jobs for the most unqualified and neediest breadwinners, while part of the foreign funds flowing into the country became housing loans to make large numbers of Turks homeowners.

Another reason to opt for construction-centered growth was to create the AKP’s own bourgeois, with the building spree proceeding along with nepotistic construction permits and public land allocations by local administrations and the central government. As such, the construction sector provided the funds to build a party state through the control of crony business people of varying caliber.

This wheel, which relied on foreign funds to continue spinning, began to slow as money became more expensive after 2014 before hitting a downturn and then crisis. Due to its links with many industrial subsectors and service sectors, among them financing, real estate marketing and advertising, the crisis-hit construction sector has begun to drag the entire economy down.

A fresh takeoff can be achieved only with the revival of domestic demand, which, in turn, requires reducing inflation to single digits, getting loan interests to reasonable rates, restoring foreign investor confidence in Turkey and the flow of external funds and dispelling the general fog of economic uncertainty. In short, it all depends on seeing a light at the end of the tunnel, which is likely to take several seasons. Before anything else, however, the AKP government needs a clear roadmap to begin climbing out of the hole. Some may claim the worst is now behind, but the truth is, Turkey has not hit bottom in the current crisis.