Turkey turmoil raises difficult questions

TXF News: The Week That Was

The Turkish economy has been overheating. Mounting external debt and the mismanagement of the economy has caused the Turkish Lira to plummet against the US dollar and delivered a serious downgrade in its credit rating. Jonathan Bell examines the consequences of the collapse and what impact this could have on you, as well as what this may mean for other emerging markets and their borrowings, plus his regular look back on the week that was at TXF.

There was a time when the months of July and August were pretty slow with not much trade and project finance activity going on. But that must have been a long time ago because I don’t recall when there was a quiet northern hemisphere (NH) summer. It used to be talk of deals being done, but today with the dearth of new decent business across many markets, the headlines are more shocking – bringing us negative news that sends further uncertainty through the trade and project finance markets. 

‘Okay, we like a bit of that’ I hear you say, ‘it creates more opportunities and better margins’. Sometimes – and only if your institution is prepared to take that market and client risk, and more importantly, that the reward is commensurate with the risk undertaken. 

So far, this NH summer has produced no end of negative news – much of it forced upon us all by sanctions and trade wars mongering predominantly instigated by the US administration. This is already having a negative impact on global trade growth and the confidence to pursue new cross-border business.

However, the latest bit of shocking news to hit us this summer, is the currency collapse in Turkey, it’s mounting problems with external debt and the potential of a complete economic meltdown. This is largely of Turkey’s own making under the leadership of President Recep Tayyip Erdogan, and the mismanagement of the currency and the economy. 

The economy is overheating and Turkey’s currency – the lira – is down around 40% since the start of this year. The lira is at 6.13 to the US dollar as of yesterday. This is slightly up from the record low of 7.2 lira to the dollar a week ago. The currency crisis prompted Standard & Poor’s (S&P) to downgrade Turkey’s credit rating to junk last Friday. Both S&P and Moody’s have said that that the currency crisis, hyper-inflation and expanding current account deficit could undermine the economy. S&P has further said that Turkey could enter into recession next year. 

So, what are the consequences of all this? What impact does it have on you? What does it mean for other emerging markets?

Turkey has large foreign currency debt and given the current, and apparent worsening economic situation, will the country be in a position to meet those debt repayments in full? In the past, Erdogan has criticised foreign lenders and their interest rates as immoral and evil and has threatened not to repay Turkey’s debts. In a worst-case scenario, is it possible that there could be some sovereign default? Could Erdogan eventually try to push for a big ‘haircut’ on foreign debt?

Turkey has always been held up as one of the leading emerging markets – along with Brazil, Indonesia, India and South Africa – the so-called ‘fragile five’. While the others have problems of their own, they do not amount anywhere near to the situation that Turkey now finds itself in. The economic situation has been deteriorating for a while in Turkey, and many economists have seen this collapse coming for some time. However, it would appear that not all international banks are fully prepared for the current situation and potential fallout, with some busily looking for escape routes or to put measures in place to lessen any adverse impact to their lending commitments. 

On the project front, there has been a sell-off of project loans. Who is buying you may ask? Well, there is nearly always someone, if the price is right! And on the trade finance front, there is substantial market risk for many leading international banks. 

For many years the market has been a magnet for international bank lending to Turkish banks for onlending to Turkish companies for their international trade activities. And those loans have been hard fought over as Turkish institutions have gradually chipped away to try and achieve ever cheaper rates from lenders. There will now be many eyes on the ability of Turkish institutions and corporates to meet their scheduled repayments. We can possibly expect some painful rescheduling from some of these entities somewhere down the line. 

On the export credit front, it was interesting to see the Danish export credit agency EKF announce early last week that they were suspending cover. In a simple statement, EKF said: “Currently, the Turkish markets are in turmoil, and EKF has decided to put new guarantees to projects in Turkey on hold.” No other ECA has, as far as I am aware, taken such action yet.   

A senior source at an export finance department tells me: “Turkey is indeed giving some headache, although the real pain may still come if and when the corporates cannot live up to their foreign debt obligations. I consider it quite remarkable that EKF (Denmark) as an ECA has already suspended cover but that is probably due to the fact that they mainly cover wind deals.”

Another leading export finance banker says of the current situation: “We are still looking at deals but very selectively. However, if we look at this market overall, I really wonder whether we, and everyone else, has ever properly aligned themselves to the real Turkish market risk. And I would have to say ‘no’.” 

This is an interesting point to consider. As I have already noted, Erdogan has always been quite vociferous about the cost of borrowing from international banks and other lenders – arguing that margins on loans are far too high. This is something which Turkish institutions have carried forward in their negotiations. 

For those with grey hair like me, we can easily recall the way some investment banks strolled into the structured commodity finance (SCF) market in Russia in the late 1990s to grab a slice of the action and in doing so dropped margins and structures to secure deals. We all know what happened, and like a lot of historic things, in the urgency to win business, some don’t seem to learn from these mistakes. Apologies, I digress!

Coming to Turkey’s rescue, if we can call it that, last week we saw Qatar pledge $15 billion of inward investment to Turkey to try to help stem the slide of the lira. Under this arrangement, the Qatari Central Bank will exchange lira for Qatari riyals, which are pegged to the US dollar. On Monday, as a first part of this agreement Qatar has agreed to a $3 billion currency swap deal. 

This is probably more about international solidarity than anything else. Although $15 billion may not seem a massive amount to the problems Turkey faces, it is significant and is more than the annual FDI that Turkey has seen in recent years. It also further aligns Turkey with Qatar, whose relations have strengthened since Saudi Arabia and the UAE imposed a regional blockade on Qatar last year. Trade between Turkey and Qatar is said to have increased by 30% in the second half of 2017, and according to the Qatar Chamber of Commerce some $11 billion worth of projects and supply contracts has been placed with Turkish companies, primarily on construction projects for the 2022 Football World Cup. 

This brings us back to the US. It was no surprise that the actions taken by Saudi Arabia against Qatar and accusations of the latter sponsoring terrorism came following a visit from the US president. And in Turkey, the country’s economic situation has been exacerbated as relations with the US have deteriorated further. This is centred around the Turkish authorities placing an American evangelical Christian pastor, Andrew Brunson, under house arrest in Turkey on charges of terrorism – which he has denied. 

This of course has put Ankara in a head-on collision with Washington. The US response has been to place sanctions on two Turkish ministers. And this has been followed up last week with the US doubling the tariffs on US imports of Turkish steel and aluminium to 50%. Erdogan has described this as “economic war”. In turn, Turkey initiated a WTO dispute complaint against the US citing 12 articles of inconsistencies etc. 

To complicate this a bit further, Turkey, is also asking the US to drop an investigation into state-owned Halkbank, which is facing potentially crippling fines for allegedly violating US sanctions on Iran. However, White House officials have said that nothing will be discussed until the US pastor is released.

All this prompted Erdogan in an Eid al-Adha festival address to state: “The attack on our economy has absolutely no difference from attacks on our call to prayer and our flag. The goal is to bring Turkey and the Turkish people to their knees.”

Of course, there is a lot of posturing here on both sides, and there is much to play out. But, the bigger picture here for all emerging markets is the cost of borrowing. I go back to my earlier remark about reward needing to be commensurate with risk. Surely, the time has come for the days of cheap money to end?

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