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.

Written by Mustafa Sönmez