🔒 Crisis in Turkey: Lessons for South Africa – The Wall Street Journal

DUBLIN — We’ve talked before about the Rand’s unexpected resilience in the face of a crisis in emerging market currencies. But as South Africa ponders a path to growth, the crisis in Turkey holds some important lessons – and some important warnings. According to this article from The Wall Street Journal, the crisis in Turkey has been precipitated by uncontrolled borrowing – in the form of foreign-denominated debt, no less – by government and corporations. What makes this scary is that South Africa has done the same thing. The country is second only to Turkey among emerging markets when it comes to external debt to GDP, and like Turkey, South Africa runs a huge current account deficit and relies on foreign portfolio flows to finance it. In other words, the vulnerabilities that have battered Turkey are present in South Africa. What sets SA apart, however, is that South Africa doesn’t have a would-be dictator trying to seize control of all the reins of power in order to build a command economy a la China. And perhaps that, more than anything, is what is protecting SA from the ravages that other emerging markets are facing. – Felicity Duncan

How Erdogan’s Push for Endless Growth Brought Turkey to the Brink

By David Gauthier-Villars

(The Wall Street Journal) ISTANBUL — The Turkish lira’s fall has been sudden and sharp. The cause traces back nearly a decade when the country’s leader decided to turn Turkey into something resembling China on a smaller scale, a world-class economy under one man’s firm control.
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Eager to pull his nation out of an economic contraction that had marred much of the world at the start of 2009, Recep Tayyip Erdogan signed a decree easing access to foreign-exchange loans for Turkish companies.

The new rules lifted restrictions that barred companies without revenue in hard currencies from doing such borrowing—as long as the loans exceeded $5 million. “It was tantamount to saying: If you drink, drink a lot,” said one official in Ankara, Turkey’s capital.

In the following years, Turkish companies gorged on euro and dollar loans, granting Mr Erdogan’s wish of brawny economic expansion that helped him and his ruling Justice and Development Party power through successive national and local elections. Memories of the 2009 recession evaporated, as did those of the 1990s crisis that had led Turkey to seek international assistance.

Mr Erdogan was, in effect, mirroring in ways the approach of Chinese President Xi Jinping and his party, which consolidated political power in an authoritarian regime and encouraged heavy borrowing to supercharge the economy.

The United States will impose large sanctions on Turkey for their long time detainment of Pastor Andrew Brunson, a great Christian, family man and wonderful human being. He is suffering greatly. This innocent man of faith should be released immediately!

— Donald J. Trump (@realDonaldTrump) July 26, 2018

I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency, the Turkish Lira, slides rapidly downward against our very strong Dollar! Aluminum will now be 20% and Steel 50%. Our relations with Turkey are not good at this time!

— Donald J. Trump (@realDonaldTrump) August 10, 2018

Turkey’s financial trouble shows the limitation of that approach, especially for countries more susceptible to the forces of global finance and without the kind of control exerted by China’s Communist Party. Vulnerabilities in the Turkish expansion model were so severe it took only two tweets by President Trump in recent weeks—one announcing sanctions against two Turkish officials and another on the doubling of some tariffs—to spark panic.

Nonfinancial corporations built a $330 billion debt pile that is now at the heart of global investor concerns over Turkey’s perilous financial situation. Compounded by a protracted dispute with the U.S. over the fate of an American pastor, those concerns have caused a currency debacle, with the Turkish lira collapsing to its lowest level ever against the dollar on Monday.

Although the lira pared some of its losses, it has shed roughly a third of its value against the dollar since the start of the year. On Friday, the lira sank more than 4% against the dollar after the U.S. administration threatened new penalties against the country over its detention of the pastor, Andrew Brunson. In late European trading Friday, a dollar bought 6.12 lira; a month ago, it bought 4.75.

The lira’s drop has sent ripples through the global financial system, raising concerns about the exposure of some European banks and denting investor appetite for emerging markets.

“It feels like going back to the 1990s,” when a deep Turkish financial crisis had ripple effects on global finance, said Zumrut Imamoglu, chief economist at Tusiad, one of Turkey’s leading industry and business-lobbying groups.

Among businessmen caught on the wrong side of the lira is Atilla Kulekcioglu. In April, Citir Usta, the food chain he founded in 2003, filed for protection from creditors over debt of more than 10 million lira. Mr Kulekcioglu said he had always resisted the temptation of contracting foreign-currency loans because clients pay in lira for the pide, a Turkish dish similar to flatbread he serves at his restaurants.

Yet, the shopping malls that house his outlets, built on the back of euro or dollar loans, charge rents indexed on foreign currencies, he said. Unable to pass on the higher rent costs to his customers, Mr Kulekcioglu said he closed 25 of his 65 restaurants and began scouting for foreign investors. “We were one of the four biggest chains in the sector,” he said.

Investor concerns over Turkey’s vulnerable finances have long been pervasive, especially as Mr Erdogan consolidated his one-man rule and increased his sway over the central bank and monetary policy. In the spring, Mr Erdogan called snap elections. And in June, he won a new five-year mandate that came with expanded executive powers, securing his political future before those concerns took hold.

The currency storm was a far cry from Mr Erdogan’s electoral promise to place Turkey among the world’s top 10 economies by the end of his term from its current rank of 17th. As the lira storm raged last weekend, the president was touring the Black Sea region, delivering speeches to thank voters for his re-election. He made no mention of the corporate-debt challenge. Rather, he denounced the tariffs the U.S. has introduced on some Turkish imports as an “act of economic war.”

“Once again, we are facing a surreptitious political plot,” he told supporters in the Black Sea town of Trabzon on Sunday. “God permitting, we will overcome this.”

On Thursday, Turkish Finance Minister Berat Albayrak—Mr Erdogan’s son-in-law—said on a conference call with about 3,000 investors and financial analysts that the lira rout was excessive and didn’t reflect Turkey’s core economic strength.

Economists say years of heavy corporate borrowing, during which liquidity minted by the U.S. Federal Reserve and other central banks met Mr Erdogan’s thirst for higher economic growth, has reached a limit.

Refet Gurkaynak, a professor of economics at the Bilkent University in Ankara, said souring U.S. relations were a trigger that awakened investors to the reality of Turkey’s financial pain.

“The problem here is that our corporate sector is deeply, deeply indebted,” he said, warning of a looming rise in defaults and layoffs. “You can’t dump all the corporate problems on the banks, so there will have to be some sharing of the problems by the banks and the government, hence the public.”

Turkish officials didn’t reply to messages seeking comment. During his call with investors, Mr Albayrak said the government would announce a detailed action plan in September.

At the start of his national political career, Mr Erdogan cut a more accommodating figure. When he became prime minister in 2003, Turkey was two years into a bailout plan run by the International Monetary Fund, receiving billions of dollars of loans in exchange for implementing the fund’s recipe of fiscal and budget rigour.

Carrying out the remaining IMF measures, Turkey reaped the benefits with lower inflation and a jump in exports, becoming a darling of emerging-market investors. Europeans greeted Mr Erdogan as a strategic partner and, in December 2004, the European Union formally granted Turkey the right to begin accession talks, kicking off large aid and investment programs.

At a conference around that time at the European Parliament, Franco-German lawmaker Daniel Cohn-Bendit walked up to the Turkish leader, video of the meeting shows. “Mr Erdogan, I have a present for you,” the lawmaker said, handing him a coin. “The first euro in Turkish.”

With the flow of money, Turkey became a construction site, as Mr Erdogan, who had developed a penchant for infrastructure projects when he was Istanbul’s mayor in the 1990s, launched train, highway and bridge projects. Istanbul’s skyline, which counted 19 high-rises when he became prime minister, now has 98, according to the Council on Tall Buildings and Urban Habitat, a Chicago-based non-profit.

In 2007, his honeymoon with the EU took a hit. Several European leaders, such as then-President Nicolas Sarkozy of France, publicly said they would veto Turkey’s membership to the bloc.

In 2008, the IMF assistance program expired. Mr Erdogan minimized the fund’s role, instead crediting his own stewardship for Turkey’s economic miracle and vowing to follow his own course.

Durmus Yilmaz, an opposition lawmaker, said Mr Erdogan and his ruling AKP party began behaving more confidently. “After 2008, they felt they knew better,” said Mr Yilmaz, a former governor of Turkey’s central bank.

That is when the global recession hit Turkey. In the first quarter of 2009, the Turkish economy shrank more than 13%. The government switched to expansionary measures such as the easing on foreign-currency loans.

Within months, the Turkish economy was back on its feet. Mr Erdogan wanted more growth and didn’t reduce budget spending. “With demand increasing a lot in an economy that was already at full capacity,” said Mr Gurkaynak, the economics professor, “we began to run the humongous current-account deficit and inflation began to creep up.”

In May 2013, then Turkish Deputy Prime Minister Ali Babacan boasted that Turkey had finished paying its $23.5 billion IMF debt. “For the first time in 19 years, Turkey owes no debt to the IMF,” Mr Babacan said after initiating the final wire transfers from a computer at Turkey’s central-bank headquarters.

Two weeks later, two tremors shook Turkey. One came from the U.S., where then Federal Reserve Chairman Ben Bernanke signalled in an address to Congress that years of Fed stimulus might come to an end. For Turkey, the message was a warning that the days of easy access to foreign funding, vital to plugging holes in its current account, could be numbered.

The other occurred in Istanbul, where a small sit-in protesting the destruction of the tree-lined Gezi park escalated into nationwide, often-violent protests against Mr Erdogan’s increasingly authoritarian rule.

Mr Bernanke’s speech and the political upheaval weighed on the lira, which lost ground against the dollar, heightening pressure on the Turkish central bank to raise interest rates. But Mr Erdogan vetoed a rate increase. In a series of speeches in June, he blamed what he called “the interest-rate lobby” for the Gezi protests and negative pressure on the lira.

“He believes the economy works in a way that is different from what the faculty says” in economic literature, said Mr Yilmaz, the former central-bank governor.

After a failed coup in July 2016, the Turkish economy shrank abruptly. The emergency rule introduced by the government spooked foreign companies, which sharply cut direct investment.

Last year, the government dramatically expanded its support to small companies through a state fund that guaranteed bank loans worth about 200 billion lira in total, up from about 15 billion in 2016. Economists say the move helped turbocharge the Turkish economy to a growth rate of 7.4% in 2017, the highest of all Group of 20 economies.

At the start of 2018, the lira was falling on simmering concerns over Turkey’s large corporate debt. Some of the president’s advisers talked on television about the need to cool Turkey’s economic engine after such a bewildering run.

But surrounded by businessmen in a hall of the presidential complex in April, Mr Erdogan distributed framed “incentive certificates” as he announced another $34 billion stimulus program.

“Some people say ‘too much growth is not a good thing,’ ” he said. “Why? Because they are jealous. It is nothing else.”

The fallout has been harsh on companies such as partly state-owned Turk Telekom,Turkey’s largest phone operator. Last month, it blamed a second-quarter net loss of 889 million lira on “unfavourable forex movements,” saying almost all of its bank borrowings, which stood at 14.7 billion lira as of June 30, were in dollars and euros. Stripping out those effects, it said, it would have posted a net profit of 676 million lira.

“Turk Telekom has debt in foreign currencies but this is at a manageable level and actually is a low amount,” a Turk Telekom spokeswoman said Friday.

Having announced this spring his intention to seek a new mandate, Mr Erdogan hit the campaign trail. He promised that a landmark mosque in Istanbul and the city’s new airport, cast as the world’s biggest, would soon be completed. He announced details of a grand project to connect the Black and Marmara seas with a canal that would house a population of seven million along its banks.

In May, the lira’s drop intensified after the president told a London conference he intended to have a bigger say in monetary policy in the future. In a bid to support the Turkish currency, the central bank sharply raised interest rates. That same month, the government reintroduced most of the restrictions on foreign-currency loans it had lifted in 2009.

“That was too late,” said Ms Imamoglu, the Tusiad economist. “They should have done it before 2015.”

Write to David Gauthier-Villars at [email protected]