Turkey

Hard landing

C3

SENSITIVE RISK for entreprise

  • Economic risk

  • Business environment risk

  • Political risk

  • Commercial risk

  • Financing risk

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GDP USD851.102bn (World ranking 17, World Bank 2017)
Population 80.75mn (World ranking 19, World Bank 2017)
Form of state Republican Parliamentary Democracy
Head of government Recep Tayyip ERDOGAN (President)
Next elections 2023, presidential and legislative
  • Important geostrategic position (that has historically always ensured aid when needed)
  • Solid public finances
  • Adequate business environment (though deteriorating)
  • Potential as regional hub between Europe, MENA and Asia
  • Exchange rate vulnerability to domestic and external shocks
  • Economic policy responsiveness
  • History of persistently large current account deficits, largely financed through short-term external debt, which has risen to a very high level in the meantime
  • (External) debt refinancing risk of weaker companies and banks, exacerbated by the currency crisis that evolved in the course of 2018
  • Deep-rooted division in society between secularists and religious conservatives
  • Geopolitical risks

Crisis evolution

For a long time we had highlighted Turkey's high vulnerability to external as well as domestic shocks owing to its persistently large current account deficits, mainly financed through new short-term external debt, which was often speculative and thus carried the risk of sudden reversal. This actually happened in the course of 2018 as investors lost confidence in the overheating economy against the background of continued policy and political mistakes (for example monetary and fiscal loosening when tightening was appropriate; disempowerment of the Central Bank; provocation of U.S. sanctions) and global financial tightening at that time. As a result, Turkey experienced a full-blown currency and balance of payments crisis by August 2018, reflected in an accelerating depreciation of the TRY, surging inflation and massive capital outflows. Eventually, in mid-September 2018, the Central Bank of Turkey (CBRT) hiked its benchmark lending rate, the one-week repo rate, by 625bp from 17.75% to 24%. This was sufficient to stabilize financial markets and halt the surge in inflation for some time. But the damage had been done. In 2018 as a whole, the TRY lost -33% vs. the USD on average. Consumer price inflation peaked at 25.2% in October and reached an average of 16.3%.

And the crisis is not over yet. In March 2019, financial markets in Turkey faced new turbulences ahead of the local elections that were held on 31 March. Foreign exchange (FX) reserves dropped by -USD7.7bn (-10%) in the first three weeks of March, triggering a renewed weakening of financial markets as investors suspected the CBRT would use reserves to prop up the currency. As the TRY fell sharply, the CBRT reacted but instead of raising its key policy one-week repo rate, it left that rate unchanged at 24% but suspended its use and began funding at higher interest rates. This marked a return to the unortho­dox “back door” monetary tightening which the CBRT had abandoned only in June 2018 – a move that has not helped improve investor confidence. The latter was further undermined by government threats against bankers and investors over alleged FX meddling.

Overall, we expect financial market volatility and risks to remain high in 2019. The TRY continued to slide in April and in the first four months of 2019 it lost -11% in value against the USD. Inflation remained at close to 20% y/y until April. For 2019 as a whole, we expect an average inflation of 17% and the TRY to depreciate by an average -20% against the USD.

Recession and rebalancing

Recession

The Turkish economy entered into a recession in mid-2018, with real GDP contracting by -1.6% q/q in Q3 and -2.4% q/q in Q4. As a result, full-year GDP growth came in at just +2.6% in 2018, down from +7.4% in 2017. Consumer spending and investment were hit particularly hard by the depreciation of the TRY. Real imports dropped (-7.9% in 2018) in line with domestic demand while exports rose by +7.5% as firms’ competitiveness improved due to the TRY depreciation.

Early indicators for 2019 suggest that these trends will persist for some time. Retail sales, industrial production, as well as imports continued to contract markedly in the first months of the year, pointing to ongoing declines in household spending and investment. Exports have continued to rise on a y/y basis. Public spending is likely to edge up slightly in 2019 as the government will attempt to mitigate the impact of the crisis. Overall, we forecast real GDP to shrink by about -0.7% in 2019.

Rebalancing

Along with the recession, after the currency crisis comes a sharp rebalancing in the tradable sector, as nominal imports of goods have collapsed (-25% y/y in Q4 2018, -21% in Q1 2019) due to the much increased import costs after the depreciation of the TRY, while exports of goods benefited (+7% y/y in Q4 2018; +3% in Q1 2019) from the more competitive currency. Exports of services should further benefit from rising tourism as visitors will enjoy significantly more affordable holidays in Turkey. We forecast that the current account deficit will narrow to -2% of GDP or so in 2019 (from -3.6% in 2018 and -5.6% in 2017).

 

Key risks

Risk #1: FX reserves

Gross FX reserves reached a peak of USD114bn at end-2013. Thereafter, they declined by -USD30bn until end-2017 and by another -USD17bn to a recent low of USD67bn in September 2018, mainly owing to frequent FX market interventions by the CBRT to stabilize the exchange rate of the TRY, as well as occasional capital outflows. Despite a slight recovery since then, FX reserves have remained volatile and stood at USD76bn in mid-April 2019. At this level, FX reserves are now barely covering three months of imports (down from six months two years ago) or just 40% of the external debt payments falling due in the next 12 months (>120% is assessed as comfortable). Even more worrisome, net FX reserves (this excludes all FX deposits parked at the CBRT by local banks) have dropped from a peak of USD70bn in 2011 to just USD30bn currently. Should serious financial market turbulences re-occur in the near term, the CBRT may at some point need to revert to capital controls in order to defend the TRY.

 

Risk #2: Corporate debt

The debt burden of NFCs in Turkey has continued to rise and stood at USD428bn or 75% of GDP in Q4 2018. This is a +43% increase since end-2010 (USD300bn) or +35pp in relation to GDP. Particularly worrisome, the FX-denominated debt of NFCs in relation to GDP surged in 2018, reaching 50% (up from 37% at end-2017). Compared to other large emerging markets, this is the highest share in GDP. Refinancing that FX-denominated debt will be challenging amid Turkey’s ongoing economic and financial crisis and the much weakened investor confidence.

 

Risk #3: Non-payment

There are clear signals that non-payment risk in Turkey is on the rise. For example, the average days sales outstanding (DSO) has increased from 65 days in 2007 to 79 days in 2018. This is well above the global average (65 days in 2018, nearly unchanged over the past decade) and puts 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 February 2019 and is forecast to reach 6% by the end of 2019.

Combined with the worrisome corporate debt position of Turkish NFCs (see above) we conclude that corporate non-payment risk will rise in 2019-2020. We forecast an increase in business insolvencies by +5% in 2019.

Trade structure by destination/origin

(% of total)

Exports Rank Imports
Germany 9%
1
12% China
United Kingdom 7%
2
10% Germany
Iraq 6%
3
10% Russia
Italy 5%
4
5% United States
United States 4%
4
5% Italy

Trade structure by product

(% of total)

Exports Rank Imports
Road vehicles 14%
1
9% Road vehicles
Articles of apparel & clothing accessories 11%
2
6% Electrical machinery, apparatus and appliances, n.e.s.
Textile yarn and related products 8%
3
5% Other industrial machinery and parts
Electrical machinery, apparatus and appliances, n.e.s. 6%
4
5% Iron and steel
Gold, non-monetary (excluding gold ores and concentrates) 6%
5
4% Plastics in primary forms

The payment behavior of domestic firms has a significant margin for improvement and normal payment terms seem excessive. In fact, as a result of the trend in long payment duration, the value of unpaid receivables has grown considerably in recent years.

  • Low

  • Medium

  • Sensitive

  • High

  • Payments

  • Court proceedings

  • Insolvency proceedings

Domestic courts lack independence, the rule of law perception is moderate, and the chances of obtaining payment through legal action are lower than through strong pre-legal negotiation efforts.

Debt renegotiation proceedings before the courts are not generalized and when it comes to insolvency issues, liquidation remains the default proceeding even though liquidation sales rarely yield efficient results and may not be in the creditors’ best interest.

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