Macro Weekly – Epi centre: Turkey

by: Han de Jong

  • Lira slide puts huge pressure on Turkey’s government
  • Contagion effects put pressure on international community to help Turkey
  • German industrial sector still under pressure
  • Chinese imports surge in July
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My colleague Nora Neuteboom has written regularly about Turkey in recent weeks and, together with Georgette Boele, has spelled out various scenarios for the country and its financial markets. Latest document TRY to recover.

The lira has come under significant pressure this year and has dropped very sharply in recent days. One assumes that rumours that capital controls will be implemented have contributed to the recent rout as people are perhaps rushing to get money out before they can no longer do that. The pressure is now also leading to contagion as the euro has suddenly fallen below USD 1.15 and the ECB is, allegedly, concerned over the exposure some European banks have to Turkish entities.

A classical case

Turkey has a large deficit on the current account of its balance of payments, 6-7% GDP, and a large short-term debt. Its funding requirement in the short term is therefore significant, so the country depends on capital inflows. The collapse of the lira suggests that foreign investors are unwilling to fund Turkey at the moment. Inflation has risen to 15% this year and is bound to rise further given what is happening to the lira. This all looks like a classical case of an emerging economy getting itself into payment problems. The outcome of such a development is usually a request for IMF assistance to avoid a default.

Not a classical case

But Turkey is not a ‘classical case’. Economic growth is strong. It is therefore easy for the government to claim that the problems are the result of some sort of foreign conspiracy.  In addition, contrary to many other emerging economies getting into this situation, the government’s finances aren’t the main culprit. Turkey’s budget deficit is not excessive, nor is its government debt. In this case, a lot of the country’s dollar funding requirement comes from the private sector. The politics are also different from the ‘classical case’. Turkey’s location makes it a country of significant geopolitical importance. Russia and China would, undoubtedly, not hesitate to try and drive a wedge between Turkey and its fellow-Nato members. And the sanctions the US have imposed on Turkey make the Turkish government more open to approaches from these countries. Last but not least, president Erdogan has concentrated a lot of power in himself, including over economic and monetary policy, which has contributed to the negative attitude of international investors. We still think that Turkey can get out of this precarious situation by itself and find the necessary funding voluntarily, but the chance that the country will be forced to look for IMF support is significant. Negotiations with the IMF will, no doubt, be tough as the Fund will most likely seek policy adjustments that president Erdogan will be unwilling to undertake.

Provide assistance

Developments related to Turkey have started to affect other financial markets as well. Other EM currencies have been pushed lower and the euro has weakened as well. So for these markets, too, it is important that some stability returns to Turkey. And I would think that for western nations it is important to keep the influence of Russia and China limited.

German industrial sector under pressure

The key macro theme of this year is the softening of confidence and economic growth in Europe and in Asia. It is not as though a downturn is imminent, but growth has fallen back from clearly above trend to roughly in line with trend. Recent German data suggests things aren’t improving yet. German factory orders fell 4.0% mom in June with foreign orders falling more than domestic ones, suggesting the problems are not so much related to the domestic economy, but to international developments. The trade conflict will play a role here, but exports, in particular to Asia, have been under pressure as well.

German industrial production fell 0.9% mom in June, having risen 2.4% in May. These series are volatile, so it is better to look at the year-on-year changes. Output was 2.5% larger than in June last year, which was down from 3.0% in April. Softer, but still clearly positive growth is not restricted to Germany, but seen in other European countries also.

Amazing Chinese imports

If the European economies are slowing due to weaker world trade growth, this must be coming from somewhere. According to German trade statistics, export growth to the emerging economies is the culprit. The most important of these is China. The most recent trade data coming out of China were, surprisingly, very strong. The yoy growth rate of Chinese imports (in USD terms) jumped to 27.3% in June, up from 14.1% in May. This may have been positively affected by Chinese importers trying to beat the introduction of tariffs in US goods. However, imports from Germany (in USD terms) reached a new record and there is no change in the tariffs for these products.

So how does one square the circle of weakening German industrial production, allegedly due to softer world trade growth, and record Chinese imports from Germany? It is a puzzle I haven’t quite solved yet.