Argentina’s latest capitulation may have helped to keep Turkey out of the headlines in recent weeks but some believe the latter’s banking sector could ultimately provide the most dramatic fireworks.
When a country has loaded up on foreign currency-denominated debt, the last thing it wants to see is a plunge in its own currency. Unfortunately, Turkey has seen just that, with the lira slumping 12.6 per cent against the dollar since mid-February.
A look at the country’s metrics is sobering. Turkey’s overall stock of private sector debt has jumped from 33 per cent of GDP in 2007 to 70 per cent today, a build-up comparable to that seen in Greece before its financial crisis in 2009, says Charles Robertson, chief economist at Renaissance Capital, an EM-focused investment bank. It is also a world away from Argentina, where private debt has barely edged up to 16 per cent of GDP.
Turkey saw the biggest rise in its financial sector debt-to-GDP ratio of 39 developed and emerging countries tracked by the Institute of International Finance, an industry association, last year.
The banking system’s loan-to-deposit ratio has risen to a record high of 120 per cent as the financial sector has increasingly relied on borrowing from abroad to fund its activities. So when it comes to total FX-denominated debt, Turkey is in a class of its own, with this figure hitting 69.5 per cent of GDP last year (up from 39.2 per cent in 2009), comfortably ahead of second-placed Poland (53.5 per cent) and Argentina (51 per cent) among 18 major EMs analysed by the IIF.
Jason Tuvey, EM economist at Capital Economics, says he “harbours fears” about the risk to Turkey’s banks, given that their 60 per cent rise in dollar lending in the last five years “may be a sign that lending standards have slipped”.
Banks’ foreign currency-denominated debt, mostly in dollars, is equivalent to 22.5 per cent of GDP, behind only the banking entrepots of Singapore and Hong Kong and (marginally) South Korea among 21 major EMs in the IIF’s database. Non-financial corporates have a further 35.9 per cent of GDP in FX debt (behind only HK and Singapore), liabilities that would also end up on banks’ balance sheets in the event of default.
At first glance, the situation bears a resemblance to that in Poland and Hungary during the global financial crisis, when a craze for Swiss franc-denominated mortgages crashed spectacularly as the Swissie rallied thanks to its haven status.
There are reasons not to fear a repeat of that debacle, however. First, Turkish households have effectively zero FX debt — as foreign currency lending to them has been banned since 2009.
Second, local banks are only allowed to make FX loans to companies that either have FX receipts or are large (and presumably sophisticated enough to hedge their exposures), says Mr Tuvey. And while Polish and Hungarian households had no FX assets to offset against their FX liabilities, Turkish companies hold $100bn of deposits with the central bank.
So far, the lira’s slide does not appear to be creating balance sheet strains, Mr Tuvey says, although some fear a restructuring at Dogus Holding, one of Turkey’s largest conglomerates, could be a canary in the coal mine.
The banks are also in good shape more broadly, with return on equity rising 2 points to 16 per cent last year and their capital adequacy ratio firming 1.3 points to 16.9 per cent of risk-weighted assets.
Moreover, the country’s share of loans that are non-performing has remained at about 3 per cent since 2013, even as the lira has plummeted from TL1.8 to the US dollar to TL4.29. This suggests the financial system can absorb temporary shocks, says Ugras Ulku, deputy chief economist at the IIF, although the figure does exclude restructured loans and those sold to third parties.
President Recep Tayyip Erdogan’s shock decision to bring presidential and parliamentary elections forward by 19 months to June 24, largely seen as a negative by markets, might also be a positive, at least in economic terms. With the elections out of the way, there must at least be a chance Mr Erdogan will be less visceral in his opposition to the tighter monetary policy that the inflation-ravaged country sorely needs.
Turkey is far from out of the woods, though, given its long-running structural imbalance between domestic savings and investment. Hung Tran, executive director of the IIF, estimates that Turkey needs to attract foreign capital equivalent to 25 per cent of its GDP every year in order to cover both its large current account deficit and the amortisation of its existing debt.
Given a backdrop of a challenging global environment and domestic political and macroeconomic uncertainty, the only way of achieving this is for Turkish assets to become cheap enough to attract sufficient international investment.