Central Bank of the Republic of Turkey (CBRT) Governor, Erdem Ba?ç? estimated that from the beginning of May through to mid-June, USD 7.9 to USD 8.0 billion has flowed out of Turkish markets.
Only about one-third of this total, was due to the rise of political instability according to Mr. Ba?ç?.
The other two-thirds was caused as a result of shifting global sentiment, triggered by actions of the U.S. Federal Bank.
Although Ba?ç? claims it has not yet caused a major problem, continued political instability will no doubt exacerbate this net outflow of portfolio investment as long as it continues.
This possibility is a primary reason why IHS Global Insight has disagreed with Fitch’s and Moody’s recent elevation of Turkey’s sovereign risk ratings to investment grade and remains fairly bearish on banking sector risks. The fact that the country relies so heavily upon “hot” portfolio investment inflows to finance its still dangerously large current-account deficit leaves the country extremely vulnerable to the kinds of shocks it is experiencing right now.
In many ways the same factors that have made Turkey an attractive target for international investment are those driving up risk in the banking sector. Turkish banks have become particularly vulnerable to changing investor sentiment through their increasing reliance on non-deposit foreign funding which, in spite of a recent increase in bond placements, remains dominated by short-term syndicated loans.
At the end of March, foreign liabilities in the banking sector stood at USD 142 billion, or approximately 16 percent of total funding – an elevated level. With a current loan-to-deposit ratio above 100 percent, such a funding profile creates significant roll-over risk for the local banking sector.
On the asset side, Turkish banks carry significant indirect foreign exchange risk emanating from the large outstanding stock of foreign exchange-denominated lending to Turkish corporations, which themselves have built up a significant negative net open foreign exchange position over the last several years. While foreign currency lending in Turkey is low by emerging Europe standards more broadly it is still significant at roughly 25 percent of total loans. Around 40 percent of loans to the corporate sector are denominated in foreign exchange.
Assuming that the worst of the protests dissipate by the end of July, the short-term outflow of portfolio investment should not cause a destabilising current-account or banking crisis.
Though yields have risen over the past week, the country’s investment-grade ratings by Fitch and Moody’s does allow the country to take on new debts to meet short-term financing obligations. Its external debt levels are low enough so that it can undertake significant new borrowing without undue stress on its sovereign position. Additionally, the country has built up ample reserves – nearly USD 114 billion as of the end of April – with which it can finance shortages for limited periods. Local banks’ access to international financing meanwhile has shown resilience to recent external shocks with banks continuing to roll-over syndicated loans and obtain relatively low borrowing rates throughout the Eurozone crisis. Furthermore, the IMF has recently noted that Turkish banks largely require corporations borrowing in foreign currency to have recourse to foreign exchange income, which should cushion these borrowers’ resilience to foreign exchange movements and prevent a significant increase in non-performing loans.
The country’s strong reserve level also affords the CBRT room to defend against the fall of the lira. After pursuing an expansionary policy throughout the first part of 2013, the CBRT had already become more cautious in May with the shift of international investor sentiment. Given the onset of the political turbulence, the CBRT is actually becoming defensive. Already, the CBRT has taken steps to support the lira, meeting with success. As of 14 June, the lira/dollar rate was back to where it had been at the end of May. The CBRT has promised further action as needed. Although he suggested it was an option that would be discussed, Ba?ç? suggested that raising interest rates was not likely in the immediate future – and in fact the Bank declined to raise the interest rate corridor at their first post-political-crisis meeting on 18 June – instead preferring the Bank’s other tools, such as the Reserve Options Mechanism, foreign-exchange offerings, and direct interventions.
However, should the protests continue, the CBRT may eventually be forced to operate in a more traditional way and actually raise rates to try to calm the markets and stabilise the lira. Such a development would in fact be welcomed from the standpoint of banking sector stability as it could serve to rein in the robust lending pace that has contributed to rising vulnerabilities in the system.
With a loss of investment inflows and a more defensive monetary policy, the short-term GDP growth outlook is deteriorating. Assuming another month or so of disrupting political problems, 2013 GDP growth could be reduced by between 0.5 and 1.0 percentage point from current levels.
(Expert commentary by Economist Alyssa Rallis Grzelak and Macroeconomist Andy Birch, at IHS)