Turkey Watch – It’s all about reforms, oh, and geopolitics

by: Nora Neuteboom

  • Today, Finance Minister Albayrak presented a new reform plan, …
  • that includes a large support package for state-owned banks
  • but falls short on some of the most needed structural reforms
  • Increasing geopolitical tensions continues to swing markets
190401-Turkey-Watch-Its-all-about-reforms-oh-and-geopolitics_final.pdf (68 KB)

The new reform plan is a good start

Today Finance Minister Albayrak presented a set of structural reforms during a special press conference. In his presentation, Albayrak focussed mostly on the (short-term) support of the banking sector and elaborated on needed structural reforms in the agricultural sector. The plan also included a credit impulse for export sectors, but we were hoping to see a more comprehensive plan on how to increase the value-added in these export sectors. In August the government will release their Export Master plan, which hopefully contains more broad reforms. Moreover, the reform packages presented today falls short on some of the most needed structural reforms, such as administrative reforms to reduce red tape and bureaucracy, measures that target the rigid labor market and educational reforms. We think the plan is a step in the right direction, but we would still like to see a more concrete guideline on how and when the reforms will be implemented.

Support of the banking sector does provide relief…

The banking sector is facing pressures because of the economic downturn. The government has already recapitalized three state banks in October last year. Two private banks, Akbank and Yapi Kredi, have also increased their capital levels. Today, Albayrak announced he will inject fresh capital (around USD 5bn) into the state-owned lenders to strengthen capital buffers. The Finance Minister will also oversee the formation of two funds to take on bad loans from banks. According to Albayrak, non-performing loans stand at 4.2% of total loans. However, a broader category of problem loans stands (NPLs and loans under close monitoring) currently stands at over 12%. This is expected to rise further given the bleak economic outlook. That said, many private banks have (foreign) parent funding, which mitigates risks. Moreover, because of the foreign ownership structures, banks have to oblige to Basel III regulations. That means that their buffers should remain in accordance to Basel standards.

… and we are not so worried about fiscal slippage

A temporary widening of the budget deficit because of increased spending and a shortfall of revenues is not unlikely given the current economic outlook. That said, we are not concerned about fiscal slippage in the coming year, as Turkey’s debt to GDP is still relatively low (around 30%). A potential source of worry is the amount of off-balance sheet liabilities including PPP’s by the government. The Worldbank estimates PPP’s to amount to around USD60bn (around 8% of GDP).

Monetary policy has returned to ‘normal’ again

Worries by foreign investors reached another peak a week before the elections, as the FX reserves of the Central Bank of Turkey (CBRT) were dropping significantly, fuelling fears that the central bank was actively intervening in the currency market (see: Turkey Watch – Local elections come with more uncertainty). A lack of communication from the CBRT caused panic in the FX market, sending the lira lower against the dollar. The authorities intervened by suspending the one-week repo auctions for an unspecified period, which implied that banks could only borrow from the CBRT trough the overnight lending facility. Thereby the CBRT basically re-introduced the corridor system, which they abandoned last year because they wanted to raise transparency. Moreover, local banks were pressured by authorities to not provide liquidity to foreign investors, which caused a surge in the overnight swap rate to a peak of 1350%. These measures have diminished both the consistency and transparency of monetary policy in Turkey, therefore lowering confidence in the CBRT’s policies.

Now that elections are behind us, we think political pressure on the CBRT will ease, making it easier to return to more conventional monetary. On April 8, the central bank resumed lending under the one-week repo (24%) again. End-March, FX reserves have increased by 5.6% on a weekly basis to around USD 75.5 bn. That said, this increase in FX reserves is largely borrowed from the financial sector and thus does not fully amount to an increase in net reserves.

What will swing markets coming weeks will be, not surprisingly, (geo)politics

Tensions between Turkey and the US have come to the forefront again. Yesterday, two US senators introduced a bill that demand the release of ‘wrongfully’ imprisoned US citizens in Turkey. Meanwhile, the diplomatic stand-off between Turkey and US over the purchase of Russia’s S-400 missile system continues. Several senators wrote an article in the New York Times, stating that sanctions will be imposed (as required by United States law under the Countering America’s Adversaries Through Sanctions Act) should Turkey decide to proceed with the S-400 purchase. On Monday, Erdogan again reiterated that the S-400 purchase was already a done deal and that they would not let Washington interfere with Turkey’s domestic policies. However, today Erdogan said the delivery of the S-400 could be postponed due to provocations from the US, indicating there is still room for ‘negotiation’. This geopolitical tensions happen against a backdrop of domestic political issues, as the AK-party is requesting a rerun of last month’s mayoral elections in Istanbul, raising concerns over Turkey’s democratic institutions.

Geopolitical issues such as these are difficult to price in for financial markets as much is dependent on the willingness of certain political figures to change position. At this moment, the purchase of the S-400 is hanging above the Turkish market as a dark cloud and if things further escalate we cannot rule out another currency crisis.