Walter Molano | Turkey: Tourism and remittances fallout
OP-ED CONTRIBUTION: EMERGING MARKET ADVISER
Like most countries, the coronavirus has been a rollercoaster ride for Turkey.
In mid-April, the number of new cases was soaring. However, the implementation of strict lockdown procedures brought the situation under control and the government began to reopen the economy by late May.
Unfortunately, as is often the case, the relaxation of social-distancing rules led to a new round of infections this month. This has been added to two other problems brought on by the coronavirus.
The first is the decline in remittances. Approximately, 6.5 million Turks live abroad, with most of them residing in Western Europe, and they are an important source of hard currency, both in the form of transfers and as a source of investment funds. Many immigrants deposit their savings in Turkish branches scattered across Europe, especially Germany and the Netherlands. These deposits are an important source of liquidity for the Turkish financial system.
Unfortunately, many Turkish immigrants work in the service sector, which has been hit hard by the onset of the pandemic.
The second problem created by the disease is the collapse in tourism. Turkey is an important summer destination, particularly for Germans and Russians. The cessation of flights has been a devastating blow for the small and medium businesses that thrived on tourism.
Not surprisingly, these problems have led to a deterioration of the current account balance. Although Turkey had managed to post a small current account surplus of 0.2 per cent of GDP last year, it has dipped back into the red. Moreover, it is expected to reach 2.4 per cent of GDP next year and more than 3 per cent of GDP in 2022.
The deterioration of the current account balance, along with heightened risk aversion, has led to pressure on the Turkish lira. The central bank has tried to stem the devaluation through heavy intervention in the foreign exchange market.
As a result, the currency has only lost about 11 per cent this year, but the central bank has also suffered a meaningful decline in reserves. This has forced it to rely on more heterodox controls, but it has also raised concerns about whether the country is headed for another balance of payments crisis.
One of the perennial worries about Turkey is the large external debt owed by the private sector, especially the banks. However, this is not a very fair assessment. No other country’s sovereign credit metrics include private-sector debt. When public and private obligations are aggregated, the country’s debt to GDP is 53 per cent. However, disaggregating the private-sector obligations, leaves the public sector with a debt to GDP of only 31 per cent on a gross basis and 13 per cent of GDP on a net basis.
A more pressing concern is that much of the debt is front-loaded and the country cannot afford further deterioration of its external accounts.
The devaluation of the currency is one of the reasons the inflation rate remains high — at 11.4 per cent. In a self-defeating move, President Recep Erdoğan strong-armed the central bank to reduce interest rates to 8.25 per cent, resulting in negative real interest rates — which only lead to more weakness in the currency. Still, President Erdoğan is sticking to his populist playbook, ensuring that the cost of credit remains low for his political base.
Consumer credit has soared since his election, leading to large increases in consumption. This is one of the reasons why Turkish GDP growth averaged 5 per cent for the decade following the 2008 financial crisis. However, the high level of consumption was also one of the reasons the country’s import bill was so high, leading to a persistent current account deficit.
The good news is the political volatility has finally subsided. After the drama of the 2016 coup attempt, the confrontations with Russia and the United States, and the noise associated with the Syrian refuge crisis, Turkey has finally fallen out of the limelight.
COVID-19 has been the main distraction for the masses, and external issues have dropped off centrestage. This respite has provided some relief for investors.
Last year, Turkey was one of the best performing sovereign credits. This year, its performance has been negative, but it still has outperformed most of its sovereign peers. Bondholders are picking up paper on the long end of the yield curve, and taking a new look at some of the subordinated bank paper.
However, the country is one that is susceptible to political and economic noise. Therefore, it may be time to take another look at its credit and begin to lighten up.
Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.