The Real Effects of External Debt on Turkey

One basic problem of Turkish economy is that the large current account deficit which is expected to equal to 4.5% of total Gross Domestic Product at the end of this year. When this is the case, the short term capital inflows and foreign direct investments (FDI) in the country becomes crucially important (Recently we published a post about the outlook of FDI in Turkey). That said, short terms capital flows into the country has come into prominence as the volatility in foreign exchange markets rises dramatically pushing Turkish lira to fresh lows, coupled with political pressure on Turkish central bank to lower the interest rates at a time when inflation remains above the official target.

Picking up on short term flows, foreign debt has been a more stable means of finance in the short term provided that domestic savings are remarkably low. This is explaining the Turkey’s heavy dependence on foreign capital inflows into its $800 billion economy. Additionally, foreign exchange reserves of Turkish central bank is known amount to $108.6 which is a figure not enough to fill the gap of short term external debt stocks that was above $130 billion at yearend.

Amid political turbulence and with the largest short term external debt stock ever recorded by its peer group, Turkish lira was expectedly poised to tumble much further. This is a short summary of what happened in foreign exchange markets. Considering the fact that Turkey like any other emerging country will be less able to receive the funds it needs to maintain its economic activities as the United States Federal Reserve pushes the risk aversion button for all markets across the globe with a rate hike, lira will add new fresh lows. But, in this post I mainly touch upon the impact of the short term external debt on economic growth.

According to the data released Turkish central bank, at year-end 2014 the total short term external debt stock of Turkey is $133 billion of which $96 billion comes from Turkish banks’ borrowings, and $36 billion from non-financial private companies. This means a 4% rise in total debt on yearly basis. The rise at year-end 2013 was 35% showing Turkish companies facing difficulties while borrowing from foreign institutions. In order to be clearer, we prepared the chart below that visualizes the annual changes in short term foreign debt stock.

Turkey - Economic Growth and Short Term External Debt

Turkish economy averagely grew 4% between 2006 and 2013, which we accept as a threshold for analyzing Turkish economic growth. As you may guess, red areas in the chart expresses the lower than average growth periods. Specifically in post-global financial crisis period Turkey clearly seems to be growing below its potential unless it posts an annual rise of 20% in short term external debt. This, of course, does not mean that Turkey’s economic growth is completely reliant on borrowing more from foreigners. But somehow two variables correlate perfectly.