A Brief History of Monetary Orthodoxy in Turkey

Since late 2010, the Central Bank of Turkey has been employing unconventional monetary policy tools primarily for price stability, and creating an environment conducive for economic development. It is hard to tell the reserve bank has succeeded in the former, and Turkey’s track record of economic growth is disputable.

Now with the CPI growth standing at the highest levels since the inflation targeting implied and fiscal policy being eased to spur the growth which has been rarely observed during the AK governments that are known for the determination to keep the public debt/GDP ratio at the low levels, it is time to look back and see how we ended up here. Please take a moment to look at the chart below.

Also note that the CBT’s average cost of funding hit its highest point at 11.96% last Friday (5/5/2017) since the the global financial crisis period.

Credit Guarantee Fund: Will It Juice Economy?

Turkish government introduced a new facility so-called ‘Credit Guarantee Fund’ a couple of months ago to boost the economic activity by spurring lending to small and medium size enterprises where majority of the country’s workforce is employed. As is Clear from its name, this is typically a system of state-guaranteed lending in which the government provides TRY25 billion in cash with the aim of creating a lending base of TRY250 billion with a leverage of 1:10. The guarantee will be offered to the banks if they keep the NPL ratio below 7%, but also note that provisioning standards was loosened by the banking regulator recently.

As we look at the y/y changes in installment commercial loans, we observe government’s push functioning as a strong incentive to increase the volume across the board. This also marked the strongest short-term momentum ever in the data set provided by the banking regulator. As of mid-April, the total amount of loans utilized by the corporates reached at TRY140 billion.

Meanwhile NPL ratios for the SME segment has been slowly but steadily rising since 2015 and current stand at 5.2%. There have been speculations around Turkey’s banking regulator’s loosening in provisioning policy led some preternatural improvements in the asset quality front. Whether it is true or not, one need to admit that we are not in a malign cycle regarding the credit metric as evidenced by the soar in bad loans.

Will these funds give way to new investments which would minimize the erosive impact of slowing growth and turn it into a faster one in the upcoming period? According to a Turkey’s daily Haberturk (see the article here in Turkish), some of the cash placed in companies is wasted on buying property and luxury cars. As evidenced by the data, corporates use the funds to close the revolving/overdraft accounts and to deposit the proceeds back to the banks. Government’s efforts, on the other hand, seemed to create an uptick in investment expenditures according to the sub-index of real sector confidence index but more improvement is needed to make a certain assessment of strength of the investments.

Turning back to the question asked at the headline of the article, in our view, there appears to be two important concerns; i-the moral hazard created with state guarantees that kind of would lead a ‘sub-prime SME lending crisis’, ii-more debt for already indebted corporates in period when deleveraging has to be an overriding theme for developing economies. That being said, this could lead some faster economic activity and earnings boost for banks in the short term, but there will a lot more talk of uncertainties in the medium-term.

Mortgage Boom in the Making

Construction sector has maintained a significant role for Turkish economy in recent years as house prices in mega cities have skyrocketed and government sponsored large projects have been under way. Now with the economy sending signals of slowdown, we not surprisingly saw some attempts to boost the industry which has been at the forefront of the country’s recent economic development. Other than transforming the skyline of Istanbul, ─admittedly not many residents of the city take a fancy to this─ this may have some unexpected and unintended implications for the economy.

Not to mention the bubble it has created and possibility of economy toppled once it bursts, we currently observe strange findings in the financial space. First, Turkish central bank has increased its average cost of funding rate, in other words the effective rate, via some unconventional methods such as acting solely as a lender of last resort rather than a central bank. Meanwhile, mortgage rates have kept falling like dead leaves and now the average rate for the mortgage production is lower than the effective rate the central bank implied, which means Turkish banks provide mortgage loans at a loss. While banks are able to offset the loss via some fees and cross selling activities, we see it as long-term risk as rates are set to be higher in the upcoming period that would leave lenders with significant interest rate and liquidity risks. Please note that banks in Turkey are still not comfortable with the funding side.

So, the question may arise as to which segment of the banking records high origination activity recently. It comes as no surprise that state-run banks again take the lead in mortgage market and outperforming the rest of the industry by a wide margin.

With naysayers in the banking community now having the upper hand across the board, one would imagine the conservative and high quality underwriting standards and solid risk management in Turkish banks where regulations have been extremely strict but functioning well, but not, likely as a part of the ongoing “structural deform” process.