Janus Henderson: Zieht die Türkei die Welt in die Krise?

A top level view of the crisis

Turkey’s current situation is largely political. The Turkish President, Recep Tayyip Erdogan, has a lot of support from his citizens, most of whom believe that its current situation is the fault of the US. Erdogan’s recent communications with the international community speaks to this; his op-ed piece in the New York Times on Friday does not mention a single piece of data, but instead runs through a litany of diplomatic complaints against the US. The new finance minister (FinMin) is his son-in-law; that does not necessarily render him unqualified but it could call his independence into question. The release of the American Pastor, Andrew Brunson, who was arrested in October 2016 in the aftermath of the attempted coup in Turkey, is a diplomatic headache but it hides Turkey’s very serious economic issues.

An abundance of external vulnerabilities
Turkey’s main issue is with its external vulnerabilities. According to JP Morgan analysts, private sector (excluding financials) debt is 85% of gross domestic product (GDP) — $722.5bn compared to a GDP of $850bn*, of which 70% is denominated in foreign currency. If we include financials, private sector debt jumps to 170% of GDP ($1,445bn) according to the OECD**. 

Similar to the banks, most borrowers have little or no foreign currency revenues, creating a large foreign currency (FX) mismatch. However, post the 2001 Turkish crisis, the country’s banks are now mostly well capitalised and the handful of Turkish corporates in our universe have adequate credit metrics. Yet, it is easy to see how prolonged Turkish lira (TRY) weakness could have dire consequences for the country, especially in the next reporting period when TRY weakness will have significant translation effects on the financial statements.

With external debt costs skyrocketing, refinancing upcoming maturities also becomes a challenge. Over the next 12 months, the private sector faces an estimated external debt repayment of $70bn; the government has around $10bn coming due. Yet, gross FX reserves in the country only amount to $81bn.

Contagion effects have already been priced in by the market (to some extent) 

• Currency — TRY weakness has also exposed other currencies in similar situations: South Africa, India, Argentina and Indonesia are just a few other countries that have similar balance of payments deficits.
• Trade — Russia, Poland and Romania would be most impacted by a decline in purchasing power from Turkey. However, Russia’s trade is concentrated in energy, which is more resilient. 
• Banking — Spain, France, and Italy are the most exposed. Spanish banking group, BBVA, owns 50% of Garanti Bank, Turkey’s 3rd largest bank by assets.

Could this be systemic? 

• Near-term: No. Banking weakness is at least 90 days away given how bad loans season. From a read-across perspective, only Argentina, Turkey and Ukraine have abnormally large external needs when compared to their amount of FX reserves. But most countries have various ways of dealing with volatility or shocks. Argentina signed a $50bn financing package with the IMF and others, raised interest rates, and is generally being proactive. China can ‘open the taps’ as they have been doing recently to respond to trade tariffs and re-introduce some money supply into its markets. Unlike Turkey (or South Africa), most countries have the political will to proactively manage their economic situation, and overall EM external financing gaps are low. In the past five years, Foreign Direct Investments (FDIs) have been trending higher while less sticky external liabilities have fallen. 
• Medium-term: 30% chance. If Turkey continues along this path of inaction, FX could stay weak, non-performing loans (NPLs) will undoubtedly rise and banks will need shoring up. Systemic risks in the banking sector will impact lenders further afield. And this outcome carries ramifications for both Turkey and the financial markets in general.

What is the endgame for Turkey?
We think that in order to turn this around, Turkey needs to announce i) a rate hike, to contain runaway inflation, ii) reforms to deleverage the private sector, iii) a bailout to repay short-term debt and capitalise the banks, and to a lesser extent, iv) release Pastor Brunson, all of this concurrently. FinMin Albayrak is speaking to investors on Thursday 16 August. We have no expectations that any of this will be announced then.

Our thoughts in summary
Overall, the main concern is that Turkey’s issues belie larger issues in the global market. A decade of loose monetary policy/quantitative easing (QE) has flooded the market with cheap foreign debt, and there are many countries and companies that simply cannot repay it when currencies are weak. 

We have not had Turkey exposure for several months now. We view its current situation as political, and experience has told us that politics is difficult to analyse and even more difficult to invest through.

*Citi, Emering Markets Economic Outlook & Strategy July 2018, Turkey GDP as at 2017

**OECD, private sector debt as a % of GDP, latest available data as at 2016