Credit Market – Turkish Market News

Turkey’s Resilience to a Fed Rate Hike

The effects on emerging markets of unconventional monetary policies implemented by some advanced economies have been a focus of debate. The policy of so-called quantitative easing that the central banks in advanced economies embarked on has increased capital flows to emerging markets. However, as these policies are scheduled to end in the near future and advanced economies are beginning to normalize their monetary policy, we are watching episodes of volatility in global financial markets. For emerging markets improving macroeconomic and financial policy frameworks and developing the financial system is crucially important for intermediating capital flows in a stable and efficient manner.

The quantitative easing had spillover effects on emerging markets through many transmission channels. The compressed term premium of assets in advanced economies increased the demand for all substitute assets including emerging market assets, as investors turn to riskier assets in search of higher expected risk-adjusted returns.

At this juncture, with the European Central Bank now embarking on its own quantitative easing, it is reasonable to ask whether we should expect to see similar on net flows into emerging markets. It is absolutely supportive of capital flows into emerging markets, but the impact will be relatively muted compared to what occurred under the US Federal Reserve quantitative easing. Investors in European assets will face strong incentives to re-balance on non-European assets. However, the small capitalization of European market compared to the United States implies that magnitude of this reallocation will be limited by comparison. Not surprisingly, we have observed a remarkable weakness in capital inflows to emerging markets following the Federal Reserve entering a tightening path despite the European Central Bank injecting liquidity to the market in order to overcome the stagnation across the continent.

By quadrupling their short-term external debt stock in 5 years of quantitative easing, Turkish banks have benefited a lot from the unconventional wave in the world of monetary policy. Analyzing the data with a timeline of the US Federal Reserve’s quantitative easing timeline clarifies the borrowing dynamics of Turkish financial institutions.

In a previous post, we pointed the sluggish credit growth in Turkey and whether it is a cause for concern around Turkey’s growth. The economic activity in the country had been fueled by the fast loan growth such that Turkish central bank turned negative on increasing lending amid qualms about the signs of possible overheating and implied a policy to keep the loan growth rate at a targeted level of 15%. Meanwhile, lending growth in the country had been increasingly dependent on external financing due to mainly two reason. First, eased borrowing conditions in the global due to aforementioned reasons had encouraged the bank in Turkey for external financing. Second, the multi-purpose monetary policy expectedly failed the lower the inflation rates below the targeted level and consequently the deposit growth considerably slowed because of offering a negative return in real terms.

So, within a higher interest environment across the global markets where Turkish lira depreciates against the US Dollar, Turkish banks are expected to deleverage voluntarily. Considering the decreasing roll-over ratios, this might be already underway. On May 8, Standard & Poor’s, the credit rating agency, pointed the issue resulting lower real GDP growth while it cut Turkey’s notch by one level in local currency terms. The agency’s real GDP projections are 3.0%, 3.2%, 2.8% and 2.5% in 2015, 2016, 2017 and 2018, respectively. Additionally, below is its expectations for Turkey’s external financing needs over the course of next four years. It is not even worth to mention that these seem as downside risks to the ratio outlook.

The challenge going forward will be achieve a solid foundation for sustained growth amid an international climate dominated by short-term interest rates. Specific to Turkish banking universe, the central bank began paying interest on lira-denominated reserve requirements which was the latest move Governor Erdem Basci to try to boost economic growth without monetary policy easing. However, given the industry has lacked a sufficient deposit growth for a while, with strengthening competition among banks this would result in higher interest rates in Turkish deposit market leading higher funding costs. Following that, the move may cause credit expansion slowing further rather than mitigating the effects of the US Federal Reserve fallout. This is likely to be the key theme in fixed income markets where the high interest rates are here to stay for a while.

Turkey is to face a number of economic challenges once the political turmoil is over and this time it will not easy to blow the clouds away.

Sluggish Credit Growth: A Cause for Concern?

The evolution of Turkey’s banking system in early 2000s was a lesson to be learned for any emerging countries, even for the developed ones. Following the 1994 crisis, Turkish financial system had come to settle in a fuzzy equilibrium with a large nominal stock of carried by a handful of banks in a lucrative “carry trade”, and a large number of lemon banks involved in tunneling bank deposits to shareholders through connected lending. Unsurprisingly, the industry had to face another crisis at the beginning of the new millennium with sizable impacts on the economy. After that, some important reforms took effect across the industry including BRSA’s (Turkey’s Banking Watchdog) main objective changing from supervision to restructuring and rehabilitation. Thanks to those reforms, things started to take shape in the financial system as well as in the economy. Banks survived through the crisis got healthier and flooded with foreign capital. With stronger financial structures and capital injections, banks in Turkey were more able to support the economy through their effect of easing overall credit conditions.

Given the eased lending environment, the total amount of credit issued by Turkish has been consistently rising. On monthly basis we have observed only three drops since 2005 excluding the financial crisis period between July 2008 and July 2009. First drop of -0.2% was in Jul 2006. After rising consecutively for 23 months, total credit saw its first monthly drop in July 2008 as the global crisis started to hit many economies across the world. Following the crisis period that is full of ups and downs in the credit market, Turkey experienced only two monthly drops in the total amount of issued credit in 63 months, in January 2012 and October 2014. Since 2005, the average monthly change has been 2.1%. Despite the tightening efforts by policymakers in order to cool down the economy, Turkish credit markets seemingly has growing since the end of 2010.

Turkey has performed the greatest expansion of its history amid the lending boom. Both domestic and foreign lenders have contributed to the transformation that made the country a $800 billion economy. As pervasive fears around the external financing rise due to monetary policy tightening in developed economies in the horizon, credit issued by the domestic institutions become more important to the economy. As discussed above, the average loan growth has been 2.1% since 2005. The next chart shows how the household consumption and the private investment perform during above and below average loan growth periods.

One thing is certain that tumbling loan creation brings recession nearer. The slowdown in non-government components of GDP nicely correlates with the lending growth. The most recent drop in the total amount of lent cash might signal that demonstrates a dramatic change in the well-greased Turkish economic machine.

The Impact of Credit on Turkey’s Growth

Credit impulse is an economic measure first introduced by Deustche Bank economist Michael Biggs. It is simply the change in new credit issued as a percentage of GDP. The conventional method measure used when associating developments in credit with developments in domestic demand is credit growth which actually is the growth in the stock of credit. But one should consider that domestic demand depends on the amount borrowed in a particular period, or the flow of credit. If this is correct, then growth in domestic demand is a function of growth in new credit issued, not growth in credit. Therefore the impact of credit on demand would also depend on the amount of credit extended relative to the size of the economy. As a consequence, the generated measure named as “credit impulse” at this stage emerges as a very helpful tool to overcome this issue.

Based on the methodology explained here, this is how Turkey’s credit impulse looks like.

I also recently posted that we would probably see a cyclical increase of consumption in the third quarter of this year. As expected this will lead a remarkable rise in GDP. Additionally, high GDP growth in the third quarter scenario was also backed by the August’s official industrial production data which reveals 5.2% rise in production activity on yearly basis as well as is visualized as follows.