Does Turkey Need IMF Anchor?

According to the Economist’s latest article on Turkey, it’s not a question but rather a settled argument.

The article expends some generic language on how the Turkish economy has been influenced negatively by the current global crisis and how the country may be vulnerable to a crisis that several other countries are already facing. So after six years of non-stop growth, the Turkish stock market, its currency as well as the growth rate have finally taken a hit. The article is quick to point out that Turkish economy has done well after the last intervention by the IMF during the crisis of 2001. The article, unsurprisingly, assumes that IMF is responsible for the successful growth registered by Turkey (as opposed giving due credit to the “hot” money flow into emerging markets during this time period causing littler bubbles in their domestic scenes, for instance) and further elaborates that Turkish economy does well in the presence of “external anchors”.

The article is yet another reminder of how often correlation and causality get mixed up to arrive at conclusions. Applying further inductive reasoning from its previous assumption of “success under IMF programme”, the article concludes that Turkey MUST refresh a stand-by agreement with IMF in order to protect itself from another crisis.

The key people of the current administration, including prime minister Erdoğan, the minister responsible for economic affairs (and former Merrill Lynch analyst) Mehmet Şimşek, and the head of the Turkish Central Bank Durmuş Yılmaz (I consider him to be a part of the AKP administration) have taken the line that Turkey does NOT need the IMF because the Turkish economy is stronger and more capable of weathering such crises than it used to be.

On top of the Economist article above, critical voices are raising their voices from within Turkey urging the current administration for a renewal of a stand-by agreement. I figure there are three basic reasons for this chorus of rebels:

1. Turkey must renew a full-fledged agreement with the IMF because that’s what the markets (and especially foreign investors) expect.
2. Turkey must do it because Ukraine and Hungary have done so.
3. It’s a good opportunity to criticize the current AKP government for “playing to the stands”, in other words, the Turkish constituency. Local elections are coming up, and certain critical voices contend that the “supposed” IMF defiance on the part of the government is a ploy to make AKP look good to the constituency that has become increasingly wary of the IMF or the EU.

Quite an existentialist dilemma indeed. I have to say after a long time of firm (and vocal) disagreement with the AKP administration and specifically the Central Bank on a lot of things that have to do with economic policies, I’m going to have to agree with them on this one. But it’s not because I take the risks of a vulnerable Turkish Lira (I still think it is overvalued despite the current devaluation “relief”) as well as the unsustainable trade deficits lightly. I’ve been ringing alarm bells on this when there were no alarms available because the world had been flushed with liquidity in the beginning of (and during most of) 2007.

How stunningly behind-the-curve such voices now sound to me is the fact I’m having difficulty explaining at this moment. Yet I don’t intend to disseminate my previous “I told you so” stuff as if I was predicting a global crisis of this sort, because I was not. In fact, I’m an optimist who sees this as an opportunity for economies to work out excesses in their system that have been created by an overabundance of liquidity as well as “hot money” entering into the relatively shallower pools of the emerging markets.

Yet a crisis is also in the eye of the beholder. If you look at the world from where I stand, given the severity of the earlier crises of the Turkish economy of 1994 and 2001, both successfully achieved under the IMF watch, by the way; the current financial situation does not sound that bad especially given the fact that Turkish banks today are surprisingly well capitalized given the lessons they’ve learned of the near past. In fact, this is precisely what Mehmet Şimşek has pointed out in the Economist article: a high average capital-adequacy ratio of 17.5% and relatively few non-performing loans.

The number 17.5% sounds a bit too high for me, and these numbers especially when spit out by Turkish authorities should be taken with a grain of salt. But it’s a fact that Turkish banks are a lot better capitalized than their European and American counterparts. So even when I lower that number to the more realistic 13.5% that professional bankers spit out for Turkish banks in general, I’m going to have to agree with Mr. Şimşek to a large extent when he makes his case for the strength of Turkish banks in general.

The word that has been floating around in Turkey, however, is that foreign banks as well as brokerage institutions own a significant share of the financial sector, and their collapse due to inadequate capital could cause a capital flight out of Turkey, thus pressuring for further declines in the Turkish currency. As it stands, there is still a serious dollar shortage in Turkey at this moment that could cause more capital flight if the global crisis were to worsen. 

I have been a vociferous critique of all the guys who have been in charge of Turkish fiscal and monetary policies on several fronts. My pet theme has been about bashing the Central Bank of Turkey regarding their decision to keep a high level of interest rates. I have been writing about the “hot money” that has been pouring into the Turkish markets, and specifically about the fact that Turkish authorities have knowingly and consciously advocated the inflow of such money in order to sustain a growth rate that depended upon cheap financing of imports via an overvalued currency.

The current account deficit of Turkey is a very significant risk that cannot be overlooked. Yet a capital flight out of Turkey is not what we should be fearful about, for such adjustments only expose (and attempt to cure) the bigger problems associated with running such unsustainable trade deficits. Please see what I wrote below a few months ago:

The overvalued currency has stifled the competitive status of local firms by suppressing exports and encouraging cheap imports, hence causing massive trade deficits. High interest rates offered to ensure the capital inflows to finance the deficit remain an impediment to sustainable growth.

Note: The Turkish Lira has lost a significant amount since then, although it has achieved considerable gains over the last few days in tandem with changes in the global markets. But both dollar and yen have made stunning gains in the global markets so the devaluation of all emerging market currencies in general need to be evaluated based on that fact.

Also after inflationary effects in Turkey are taken into the consideration, it turns out that the Turkish Lira has reached nowhere near breaking any records of devaluation in real terms even at its recent lows. To make this point clearer, if a country experiences 10% inflation year over year when its nominal currency stays the same, it means that the currency is gaining value in real terms. It’s a very simple economic concept that I’m having difficulty explaining to fellow Turks who personally experience this relative gain in currency even when there’s no nominal change.

I’m waiting for the official October data to become available on Turkish Central Bank’s web page to see where the Turkish Lira actually is after taking purchasing power parity into consideration as well as a weighted basket of currencies. Also given the fact that the rest of the world is lowering interest rates, the Turkish rates have become even more attractive, and this factor has also made it very difficult thus far for an extensive capital flight to happen.

I have been very adamant about the following viewpoint, and I repeat: Such capital flights and the ensuing devaluation of the currency need NOT cause severe damages within an economy as long as preventive risk management techniques and necessary liquidity valves (for emergencies) have been instituted throughout the economy.

Of course the important question is whether such preventive as well as emergency measures are being instituted by the administration or taken seriously by various firms of the private sector. The consensus among Turkish businesses is somewhat negative on that one. They believe that the administration is not doing enough, whereas the administration insists that they have been warning businesses about necessary capital adequacy requirements as well as dangers of borrowing in dollars. So I guess because enough warnings have been issued, it’s not going to be the administration’s fault when and if a more severe currency crisis unfolds in case of a stronger capital flight out of the country.

So off we go with the familiar game of walking and dancing until the music stops. An erosion of confidence wreaks havoc in any economy and that very thing happened not long ago in Turkey when all liquidity and credit dried up in the unfolding of the crisis of 2001. Ironically these experiences have taught a thing or two to all players in Turkey and especially the financial sector. Thus we need to take some significant positives into account when evaluating the current robustness of the Turkish economy as well as its ability to withstand the global crisis. 

Several good news: First one is the strong capitalization of the Turkish financial sector. This fact has been duly noted by those who wish to tout the administration’s economic accomplishments. The other good news especially for creditors of the Turkish government is that a large portion of the Turkish government debt is in Turkish Liras. So a hypothetical capital flight along with further devaluation of the local currency is not going to create a lot of strain on the government’s ability to pay its debt denominated in dollars or euros. 

Thirdly, the current devaluation of the Turkish currency has come with the collapse of global energy prices across the spectrum. This is yet another divine gift to the current administration as well as the Central Bank of Turkey in their efforts to deal with the much-anticipated correction of the currency. As an importer of most of its energy, Turkey has also been extremely vulnerable to increases in energy prices coinciding with a devaluation of its currency. A serious disaster has potentially faded away at this juncture because the global economic crisis has synchronized with the collapse of energy prices. Another side effect of this will be the easing of further inflationary pressures because energy imports will not be as expensive as feared otherwise, due to the fact that Turkey is a net importer of oil.

However, a weak spot exists for Turkish firms that have increased their overall dollar denominated debts to about threefold since 2002. Firms outside of the financial sector have not instituted the kinds of risk management procedures that banks have. In fact, the adequacy of the capitalization of firms outside of the financial sector is very questionable and this comprises the weakest link of the Turkish economy. It is conceivable that these players will weaken the economy’s ability to withstand such a crisis. Further possible devaluations of the currency may wreak havoc with firms that have depended on cheap dollar financing when the liquidity used to be so available.

So Turkey needs sound capitalization rates both within the financial sector and beyond as well as access to credit and liquidity in case of emergencies in order to be able to navigate the crisis created by a potential outflow of capital from the country. Simple enough that.

Mr. Yılmaz, the head of the Turkish Central Bank, has contended that Turkey does not need IMF money “at this juncture”. Of course, a serious capital flight has not happened due to several economic as well as monetary policy reasons I’ve explained above and also given the current global market relief rallies.

Yet the necessary credit and liquidity valves must be available at the right moment. So far no domestic plans have been announced to help the easing of a potential credit and liquidity crisis that would obviate the need for an IMF rescue. I agree that Turkey has the capability to create an alternative plan to an IMF rescue package and this solution can be home grown. But so far no satisfactory packages or specific and detailed solutions have been announced. All of this indicates that Turkey may likely run into IMF’s arms when and if real trouble starts. So all this “We don’t need the IMF” talk may turn out to be a “play to the stands” indeed.

Comments

[mlkr:]

Suna'nim; isnt turkiye's economy better positioned than Equador decided not to utilize IMF funds ?

2008 Nov 01 03:40 PM