Kemal Ataturk, founder of the Republic of Turkey, must be trying to break out of his mausoleum by now. Is it just coincidence that, at the centenary of the dissolution of the multi-ethnic Ottoman Empire (the original “Sick Man or Europe”) in 1918, Turkey finds itself under a new executive president, whose official residence in Ankara rivals the legendary palaces and mosques of Istanbul in scale, if falling somewhat short on architectural merit?
One could argue that the current and growing economic crisis in Turkey (compounded by its political spat with the US) was unexpected. However, in reality, it had been building for some while, particularly in the wake of the attempted coup in 2016, which led to the gutting of much of the bureaucracy for its supposed Gulenist tendencies and the intimidation of some of the country’s leading business conglomerates through the (mis)use of the tax system, leading to increasing uncertainty over FDI. In addition, the President quite clearly suborned the supposed independence of the Central Bank in order to keep interest rates lower than they would otherwise have been. While this is not exactly unique behaviour for a politician, it added to the belief that economic policy was now subject o the whims of an individual who believed that, somehow, the usual outcomes would be avoided.
All this is somewhat ironic, as, during the early days of his period in government, now-President Erdogan and his senior AK Party colleagues restructured Turkey’s economy in ways that brought it into the modern era and enabled a significant rise in productivity and standards of living, as well as the prospect of full membership of the EU. As a result, there was hope that the economy could escape from what had been a cycle of boom and bust, with its dependency on foreign currency borrowings, and persistent structural weaknesses in its balance of payments.
That achievement is now under serious threat, with potential consequences that reach far beyond the country’s borders, as questions arise about the possibility of a new emerging markets crisis, with Turkey as the tipping point.
Firstly, while not yet quite in freefall, the Turkish lira is doing a very good impression of repeatedly diving off cliffs to reach successive lows against the US Dollar- down over 40% year-to-date. Amongst other things, as the FT pointed out, this now makes the cost of oil imports (always a weakness for the economy) in Lira terms almost 3 times what they were when Brent crude peaked at USD 147.50/barrel in 2008.
Secondly, the US is using sanctions against Turkey on items such as steel and aluminium to try to compel the Turkish government to release a detained US citizen. Again, hardly unique, but it adds to uncertainty over the extent to which the US will arbitrarily use sanctions over even the smallest perceived “slight”. One wonders when the “gunboats” will appear on the horizon
Thirdly, the ECB is clearly becoming worried about the impact of events in Turkey on the balance sheets of several major European banks (a re-run of the Greek debacle), whom we suspect will not have fully modelled the deteriorating scenario now unfolding. Already credit spreads on those seen as having the greatest potential exposure are widening.
Fourthly, there is likely to be a major showdown over the use by its NATO “allies” of Turkey’s key Incirlik air base, which is vital for providing aircover across numerous US and NATO military operations in the region.
Fifthly, good old-fashioned roll-over risk is returning within the Turkish banking system; with the BIS estimating that the system’s external liabilities now exceed its external assets by almost 3:1. In addition, it seems inevitable that the quality of domestic banking books will deteriorate.
So, definitely another situation to add to the list of stressors for the global economy, even if that beach holiday in Antalya’s “Turkish Riviera” is now much cheaper.
As always at Awbury, even when we have no direct exposures, we are monitoring potential second- and third order effects. Long experience has taught us that failure to pay attention to rapidly-changing systemic dynamics can have unforeseen and unfortunate consequences. No August “off”!
The Awbury Team