Financial System – Turkish Market News

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 Outlook of Foreign Direct Investment

Turkey is running a large current account deficit and is a big borrower from abroad as the deficit roughly accounts for 6% of the country’s total GDP and short-term foreign debt stock hits $130 billion. Under such circumstances foreign capital would suppress the rising concerns around the country’s debt. However, Turkey seems to be less attractive to consistently high foreign direct investments leaving the country less able to deal with the stress on its financial system.

The sharp decline in oil prices will ultimately help Turkey to narrow its deficit but in the long-term Turkey needs sustainable tools to finance it, and that sustainability requires the financing quality. What is more lower oil prices could lead the deficit above 5% of GDP which means the country may still have some substantial headwinds to face arising out of its deficit.

As it is well known, foreign direct investments is the solution to this monstrous problem. The question then arises as to how successful Turkey is to attract these investments (see the chart below). At first glance, it may appear unsuccessful to do so, but looking again, the main reason that causes such huge differences in inflows to country is the weakness in Europe. Many European countries have had their own problems since the financial crisis and many businesses as well as banks in the region are struggling with the slowdown. Therefore the current economic situation in the continent is not conducing Europeans to look at investing in emerging countries.

When it comes to make a peer comparison, Turkey cumulatively is the worst performer with regard to attract foreign direct investment inflows alongside with Indonesia among major emerging countries since 2005. According to the data compiled by the OECD, a total amount of $131 billion is invested in Turkey by foreigners, while the foreign direct inflows to other member of BIITS is averagely $275 billion during the same period.

Despite the above-mentioned gloomy developments, Turkey still has the ability to offer important value to many investors across the globe. For instance, Turkish ministry of energy recently started offering healthy incentives for power generation from renewables which is an area with high potential. Additionally, the near future hold some remarkable privatizations in store, including Borsa Istanbul, Halk Sigorta and Halk Emeklilik, the insurance and private pensions companies; Igdas, the natural gas distribution company; Botas, the petroleum and natural gas pipeline and trading company; toll roads and bridges; horseracing and Spor Toto, a lotto company.

Turkey needs to tip the scales in its favor in foreign investments to be able to overcome the financing issue. Turkey has valuable resources to ease the problem, but also is facing headwinds mostly due to rising global risk aversion.

The Role of State in Credit Crunch

Only limited number of voluminous bagfuls of hot air have been spent by various economists about the alleged shortage of liquidity in the Turkish financial system that I have written in the past (see here, here, and here). Rather than repeating myself in a blog post by questioning the availability of cash in Turkish banking universe, this time I better focus on how our state-run banks have been performing and how much risk they are at in term of liquidity.

A liquidity meltdown following a credit crunch is how every great illusion ends in promising emerging markets. For a while concerns has grown over the threat of Turkish credit crunch, however, policymakers in Turkey overcome the issue in 2012 by providing one of the lowest growth rates recorded in any other emerging country excluding the recession periods. Since mid-2013 the government has had to struggle to survive from its most deepest political crisis starting with Gezi protests and continuing with graft scandal. As a result the banking sector’s loan growth slowed down due to concerns rising together with political risk, excluding the state-run banks. Not surprisingly loan brokers employed by the banks under the control of the government has seemed very comfortable while placing funds into the economy.

Then liquidity dies.

Above-showed chart is definitely not a say goodbye to your pension and deposit signal, but for now.

Recently the whole country is informed about these state-run lenders are leading the loan package of $6.1 billion to finance the construction of the Istanbul’s third airport which is called “a monument of victory” by Prime Minister Erdogan.