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.
There is a rising concern that house prices in Turkey are increasing at an unsustainable rate. According to the Turkish Central Bank’s data, Turkish house prices have consistently grown for the last several years. The chart below shows the rise in inflation adjusted housing prices in the country and specifically in three of the country’s largest cities, Istanbul, Ankara and Izmir. Istanbul’s whopping home price surge means that its housing bubble may be able to slam London’s or Shangai’s. Considering the housing price dynamics in two other large cities in Turkey, the housing market in Istanbul is probably driven by irrational exuberance. There is no need to mention that this makes the most populous metropolitan area in the country unaffordable for young people causing shortage of skilled labor, or it increases wealth inequality between home owners and renters. But, an unsustainable boom could also lead to an eventual fall in prices, with corresponding bank losses and negative wealth effect. There one should note that the expensive house prices in city threaten the economy of the city in various ways.
During post-2008 global recovery period, low interest rates has been one of the main theme of the economies across the global as well as in Turkey. As expected, low rates reduced the cost of mortgage payments, making buying a house relatively attractive. This eventually increases in demand for housing is one significant factor in pushing prices. The chart below shows that total mortgage loans showed a solid growth and stood at 25% as of total GDP in Turkey at the end of 2014. Still, the figure looked less threatening compared to the countries that suffered recessions due to the housing market bubbles. So, technically, if we ignore the deteriorating business confidence, a potential bubble burst will have a limited effect on the financial system. However, it is not hard to imagine what would happen in case of a housing market crash in Istanbul, where the heart of Turkish economy is at, that is, likely to turn the country from a success story to a part of emerging market bubbles.
UPDATE on 3/28/2016:
Guess what happened in January.