After taking power in 2002, the Justice and Development Party achieved economic growth through its policies of granting funding to the private sector to carry out mega-projects, pumping credit through commercial banks, and attracting foreign investment. These policies encountered a hurdle, however, when foreign credit costs began to rise as a result of the change in policy made by the main central banks around the world in the aftermath of the 2008 global crisis.
While Erdoğan’s expansionary economic and fiscal policies managed to delay the economic crisis, they were not sustainable. In late 2018, the Turkish economy stagnated, and it will face real challenges in 2020.
The dilemma of national debt and the growing risk of investing in Turkish assets
The main problem facing the Turkish economy is the rising national debt, which has reached US$ 447 billion. The debt-to-GDP ratio sits at 61.8%, the highest in Turkish history. Almost half the debt belongs to the private sector; private investment has waned as a result of the accumulation of debts, leading to a decline in growth, to stagnation, and to financial instability.
The Turkish government has tried to rescue the largest Turkish companies facing financial difficulties by transferring their bad loans to the Turkey Wealth Fund. The value of the Fund’s assets will begin to decrease if new financial turmoil occurs, however, which will have an impact on the total size of its portfolio, particularly as global investors are not expected to accept the risks present in Turkish assets, especially given that the data provided by the Turkish government lack transparency.
These developments have coincided with a growing strain in Turkish–American relations, following Turkey’s purchase of Russian-made S-400 missile systems and the clash in the two countries’ policies on northern Syria. The USA is therefore considering imposing economic sanctions on Turkey under its Countering America’s Adversaries Through Sanctions Act (CAATSA), which provides for two main types of sanctions: the exclusion of Ankara from the SWIFT system (for financial transfers and transactions between banks), and the punishment of any American companies or their international partners that attempt to invest in Turkish assets. These two types of sanctions will have a destructive effect on the Turkish economy. Turkey is weighed down by its debts to foreign bondholders, and the vast majority of its capital comes from the USA and its allies. Moreover, the inability to use the SWIFT system will have a direct impact on Turkey’s imports and exports.
Even if less severe CAATSA sanctions are imposed, investment risk premiums in Turkey will still increase, which will drive up the cost of corporate and state finance. The exchange and bond markets are also expected to become more volatile. While the sanctions will not cause the complete collapse of the Turkish economy, they may damage it severely, leading to the deterioration in global economic conditions for the country within the same period.
The main challenge facing the Turkish economy is the difficulty of obtaining foreign finance at a reasonable cost, owing to the magnitude of the country’s debts. Payment on 50% of the government’s domestic debt will need to be deferred in 2020, and US$ 175 million in foreign debt will mature within the next 12 months. Consequently, the greatest challenge that the Turkish economy will face in 2020 is the repayment and postponement of its debts. While the failure to extend the maturity period will lead to a decline in economic activity, efforts to extend the period will drive up interest rates and the dollar exchange rate. This is a cause for concern in and of itself, and can be avoided only if global investors accept the risks.
It would therefore be wise to describe 2019 as a year of semi-recovery before the next shock, rather than one of complete recovery. Small and large holding companies will face serious difficulties in obtaining the funds required to continue their operations. While the collapse of a major bank is not inevitable, it cannot be ruled out if the global recession hits Turkey hard. Although the government made real efforts to delay the crisis until 2018, and has used almost every option to mitigate the negative impact on both commercial entities and the people in 2019, it has no more resources available to combat the economic crisis in 2020. The magnitude of the global recession and its positive side effects will be key determiners of the strength or weakness of the Turkish economy.
The social and political impact of the economic crisis must also be taken into account, in particular as unemployment rates in Turkey are at an all-time high and are expected to remain as such throughout the coming year. Although the Turkish government has tried to reduce real wages to make labour costs acceptable for the private sector, this will also weaken the purchasing power of the working class. Resentment among the various sectors of Turkish society will grow, and the government’s satisfaction rating may continue to fall.
EPC | 20 Oct 2020
Mohamed Fawzi | 19 Oct 2020
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