Interest rate-foreign exchange rate conflict under the shadow of politics
Mustafa Sönmez Hürriyet Daily News- March/ 02/ 2015 In Turkey’s economic agenda, as in several…
US President Donald Trump’s underperformance on his pledges has directed global funds back to emerging economies, including Turkey. Propped up by the inflow of foreign capital, the Turkish economy has begun to pull itself together, returning from the brink of the crisis that occurred in the second half of 2016 when its growth rate had dropped to 1%. The Justice and Development Party (AKP) government looks set to close the year with a growth rate of 3.5% to 4%, notwithstanding the many problems accumulated in the meantime, including the budget deficit, bad loan risks, a growing current account deficit, ossifying unemployment and double-digit inflation.
The dimming prospect of Trump following through on promised reforms such as tax cuts and infrastructure investments has brought about the prospect of slower rate hikes by the Federal Reserve, which — coupled with ongoing liquidity expansions by the European and Japanese central banks — means the return of the period of abundant and cheap money. As the flow of global funds to emerging economies intensifies, local currencies are gaining ground against the dollar and interest rates are on a downward track.
The perception of uncertainty over the US economy has weakened also hopes of growth expanding from 2% to 3%. All this is slowing down the Federal Reserve’s pace in hiking rates. Some had initially argued that 2017 would see four hikes, but the expectation dropped to three. Now, with the Trump factor, this is dropping further to two hikes.
Trump’s stumbles have already led to revisions in growth forecasts for the American economy. In the June edition of its Global Economic Prospects report, the World Bank cut its 2017 forecast by 0.1 points to 2.1%, well below Trump’s goal of 3%. According to the report, global economic growth this year will be led by the seven biggest emerging economies: Brazil, China, India, Indonesia, Mexico, Russia and Turkey. Noting that the Turkish economy was recovering fast, the World Bank raised its growth forecast for Turkey by 0.5 points to 3.5%.
In sum, the Turkish economy has managed to gain momentum and weather the dangerous crisis for now, aided by the tailwinds of returning global funds thanks to Trump’s stumbles, in addition to a series of measures that Ankara enacted to steer the ship away from the storm.
According to President Recep Tayyip Erdogan, 2017 could be “the year of a historical leap” for the Turkish economy. “The rally at the stock exchange and the fall in foreign exchange rates are signs of the markets’ full confidence in the economy,” he said June 3 while speaking at the general assembly of a business association. Urging the business community to resume investments, he added, “Now it’s time to act. Don’t be late. Seizing investment opportunities in times like this would yield greater gains. Use all your means and courage to invest, produce, export and expand employment.”
Starting from September 2016, international credit rating agencies had cut Turkey to non-investment grade. Still, Turkey managed to lure a new flow of short-term investments from abroad, which halted the rise of the dollar and even pushed it back. As a result, domestic demand and even exports perked up, stimulating growth.
The foreign short-term portfolio investments — known also as “hot money” — had begun to increase in February. In the first five months of the year, net foreign investment in Turkish stock shares and government bonds reached $4.3 billion. As a result, the price of the dollar — which had soared to 3.73 Turkish liras in January — declined to about 3.5 Turkish liras in June. The greenback could have retreated even further, but the Turkish private sector sustained the demand for dollars, scrambling to close its large foreign exchange deficits. Consequently, the net foreign exchange deficit of private companies fell to $196 billion in March from $211 billion in November.
The main stimulant of the new growth momentum came from the big incentives the government offered to the private sector, including more than 180 billion Turkish liras ($50.7 billion) in loans issued under the Credit Guarantee Fund — a measure that reduced stress both in the real sector and on the banking front. Another notable factor was the relative easing of political uncertainty after the April 16 constitutional referendum.
The revival in exports has also begun to contribute to growth. According to Economy Minister Nihat Zeybekci’s estimate, exports contributed 1.5 points to the growth rate in the first quarter, which is scheduled to be officially released this month.
Attractive interest rates have been instrumental in drawing external capital to Turkey, and most of the foreign money has gone to government bonds. With the yield on the Treasury’s benchmark two-year bond fluctuating between 11% and 11.5%, Turkey is the highest-yielding country among the so-called “Fragile Five,” which include also Brazil, India, Indonesia and South Africa.
Yet there is also the other side of the growth-glowing coin, where new fragilities are emerging on top of existing ones. The unemployment rate, for instance, reached 12.6% in February. Inflation hit 11.7% in consumer prices and 15.3% in producer prices in May, emerging as one of the most serious problems in the short run. Tourism revenues, meanwhile, signal a decline even in comparison with 2016, which was already a crisis year.
The government’s lavish spending and various incentives to avert the crisis, including corporate tax discounts, premium supports and reduced VAT rates, will all mean budgetary strains in the long run that would upset public finances. Ultimately, the lower classes will end up paying the price.
There is also the question of what will happen at the Credit Guarantee Fund, which has sponsored the issuance of Treasury-guaranteed loans totaling some 180 billion liras, with maturity terms extending to 10 years and often including grace periods of up to three years. The volume of the fund itself was raised to 250 billion liras in March, which led public banks in particular to lend lavishly in the run-up to the referendum. This may result in clamors when reimbursement time arrives.
The banking sector’s loan volume has expanded by 160 billion liras this year, but lira deposits have increased only by 33 billion liras — even though banks have raised yields to up to 15% per year. This means a significant shortage of resources in the sector, and the Central Bank is being used to overcome the problem. The inevitable outcome, many fear, will be more inflation, more bad debts and more burden on the public budget.