External imbalances will narrow but remain elevated in 2021
Along with the recession in 2018-2019 came a sharp rebalancing in the tradable sector as nominal imports of goods and services collapsed due to the much increased import costs after the depreciation of the TRY. At the same time, nominal exports benefited from the more competitive currency. Exports of services also benefited from rising tourism as visitors enjoyed significantly more affordable holidays in Turkey. As a result, the annual current account balance shifted into a small surplus of +1.2% of GDP in 2019, after 17 years of (mostly) large deficits.
However, the rebalancing peaked in September 2019 when the rolling 12-month current account surplus reached +USD12bn (equivalent to almost +2% of GDP). Against the backdrop of rapid monetary easing and re-surging credit growth, the monthly current account has been back into deficit since December 2019. In 2020, nominal exports dropped by -18% (-USD43bn) as a result of reduced foreign demand for Turkish goods and services (notably tourism) in the wake of the global Covid-19 crisis. At the same time, imports remained broadly stable in USD terms. As a result, the current account posted a shortfall of -USD37bn in 2020 as a whole, equivalent to approximately -5.1% of GDP, the highest annual deficit ratio since 2013. Moreover, the financial account registered net short-term capital outflows of -USD10bn (-1.4% of GDP) in 2020. This combination of a current account deficit and net capital outflows confirms that a balance-of-payments crisis was underway in Turkey last year. Meanwhile, only 13% of the 2020 current account deficit was covered by net foreign direct investment (FDI) inflows which have a longer term nature.
For 2021, we expect a partial rebalancing. Exports should get a boost from Turkey’s increased competitiveness owing to the weaker TRY (as compared to the average exchange rate in 2019-2020) while import growth should be curtailed by the weaker currency and slowing credit expansion due to the tighter monetary policy. We forecast annual current account deficits of around -3% of GDP in 2021-2022. However, net FDI inflows will remain modest, as they have been over the past two decades. Whether or not the capital outflows from 2020 can be reverted in 2021 depends on investor sentiment towards both Emerging Markets in general amid the ongoing pandemic as well as towards Turkish politics and policies in the coming year.
The sharp decline in FX reserves is very worrisome
Gross FX reserves reached a peak of USD114bn at end-2013. Ever since, they have been on a volatile downward path, mainly owing to frequent FX market interventions by the CBRT to stabilize the exchange rate of the TRY, as well as occasional capital outflows. At the end of 2019, reserves stood at USD79bn. Then they dropped by -52% to just USD38bn in September 2020 due to capital outflows and CBRT intervention in the wake of the Covid-19 crisis. Following the sharp monetary tightening in Q4 2020, reserves recovered modestly to USD43bn in January 2021. Yet, at this level they are covering less than three months of imports or, in other terms, less than 30% of the external debt payments falling due in the next 12 months (> four months and >125% are assessed as comfortable, respectively). Even more worrisome, net FX reserves (this excludes all FX deposits parked at the CBRT by local banks) dropped from a peak of USD70bn in 2011 to an estimated USD20bn at the end of 2020. Overall, the CBRT’s FX reserves are way too low to defend the TRY if needed. Should serious financial market turbulence re-occur in the near term, the CBRT may at some point need to revert to capital controls in order to defend the TRY or release the currency into free fall.
Corporate debt and non-payment risk will remain high
The total debt of non-financial corporations (NFCs) in Turkey declined from a peak of USD570bn in Q1 2018 to USD437bn in Q4 2020, thanks to the deleveraging in the wake of the 2018 domestic financial crisis and the 2020 Covid-19 crisis. However, it has increased from 69% of GDP in Q1 2018 to 76% in Q4 2020 because nominal GDP in USD has declined due to the massive currency depreciation over the past three years. Somewhat improved, though still worrisome, the FX-denominated debt of NFCs in Turkey fell to 34% in relation to GDP at end-2020 (from a peak of 46% in Q3 2018) and to 45% as a share of total NFC debt (from 59% in Q3 2018). Refinancing that FX-denominated debt will remain challenging as NFC balance sheets have been stressed by the TRY depreciation, volatile interest rates and low growth, while investor confidence has remained weak.
There are clear signals that non-payment risk in Turkey has been on the rise. For example, the average days sales outstanding (DSO) increased from 65 days in 2007 to 82 days in 2017 before falling back slightly to 76 days in 2019. This was well above the global average (64 days in 2019, nearly unchanged over the past decade) and has put Turkey among the countries with the longest DSO. Another signal is the share of non-performing loans (NPLs) in total loans, which has increased from a recent low of 2.8% in May 2018 to 4.1% in December 2020. Most of those NPLs are to Turkey’s ailing energy and construction sectors. Combining this with the worrisome corporate debt position of Turkish NFCs, we conclude that corporate non-payment risk will remain on the cards in the next two years. We forecast an increase in business insolvencies by a cumulative +17% in 2021-2022, after a +12% rise in 2020. - March 2021