Treasury guarantees evoke habits of crisis-ridden old days

In line with Prime Minister Recep Tayyip ErdoGan’s repeated commitment that his “mega-projects will be completed at any cost,” the Treasury has offered a shield of infallibility to such guarantees with a regulation issued last sunday.

Despite a few weak voices in support of the new regulation, which seeks to support colossal infrastructure investments, numerous experts have adopted a critical stance against it, warning that this regulation may be a harbinger of retrogression to the ominous pre-2001 economic crisis era of lost fiscal discipline and crony capitalism.

According to the regulation prepared by the undersecretary of the Treasury and published in the Official Gazette on April 19, debts stemming from carrying out build-operate-transfer (BOT) projects over a minimum investment amount of $1 billion and projects of the Ministries of Health and Education with a minimum investment amount of $500 million will enjoy protection from the Treasury.

That is to say, if tender-winning companies or consortiums become insolvent and hand over their projects to the relevant state administrations, the Treasury will take over all their liabilities, even if the construction projects have not broken ground.

Eighty-five percent of loans associated with the project will be covered by the Treasury if a project fails or is suspended due to a fault on the part of the company, while 100 percent of the costs will be covered if there are problems or shortcomings for which the relevant company is not responsible. seeing as the Treasury’s money is the people’s money at the end of the day, citizens — who will not have a share in the profits of a private company that successfully completes a project — will be compensating for the faults of that company.

The Treasury has not released a statement to explain the rationale of this new system. But Economy Minister Nihat Zeybekci fended off criticism of the new regulation on Monday, saying that 95 percent of major BOT and build-lease-transfer (BLT) projects, including nuclear power plants and highways, would not fall under the umbrella of the state-guarantee system, and that guarantees from the Treasury serve national interests.

Parliamentary control

Ercan Kumcu, an economist who formerly held the positions of secretary-general and deputy governor of the Central Bank of Turkey, approached the issue in his column in the Haberturk daily. He said critical views about the expansion of the Treasury’s guarantee system are understandable considering the abuses it has caused in the past, particularly before the 2001 economic crisis.

“But it is not appropriate to completely reject the system just because it has been abused in the past. If utilized correctly, it may be a very useful tool to draw investments forth,” he commented. In terms of the optimum method to employ such guarantees correctly, Kumcu believes they must be assigned by Parliament since it may become a burden on the state if things go wrong.

The Treasury had already promised guarantees for selected investments, solely for public companies or institutions. The amount to be referred as the maximum threshold for the delivery of these guarantees was being determined annually by the Treasury; it was $3 billion for 2014. The latest regulation just about removed this limit and broadened its scope to cover private sector investments as well.

The liability undertaken will be registered as the state’s external debts. In other words, if a company carrying out a project with a predetermined assessed value of over $1 billion in a BOT model decides to terminate the contract or defaults on its debt for a particular project, its bank loans will be paid by the Treasury, which means by the public.

Turkey’s ongoing mega-projects are automatically included in the scope of this new regulation. An information notice from Akbank found that the total value of the current mega-projects is $53 billion. Most outstanding of them are a new third airport project in Istanbul, with a projected value of 22 billion euros; city hospitals worth TL 20 billion; a third bridge worth $2.5 billion; and a highway between Gebze and Izmit with a projected value of $6 billion. It is estimated that the ongoing and planned mega-projects will need $300 billion of funding in the coming nine years.

The Treasury guarantee system was prevalent before the 2001 economic crisis. Between 1995 and 1999, the sum of guarantees provided by the Treasury for BOT projects was $8 billion, which caused trouble for payment balances and eventually led policymakers to set annual limits for the guarantees starting in 2002. According to data provided by the Department of the Treasury undersecretary, public companies under the patronage of the Treasury took loans amounting to $2.5 billion in 2013 scathing fiscal discipline

Economists also warn that the system may inflict serious damage on fiscal discipline, one of the government’s biggest achievements since it came to power in 2002. The rate of debt over gross domestic product (GDP) was 74 percent in 2012, while it sunk to below 40 percent as of last year, and public sector borrowing requirements retreated to 20 percent from 66 percent. The rate of the budget deficit over GDP also plummeted from 12 percent to as low as 1 percent, all thanks to the fiscal discipline to which the AKP government’s economic administration unwaveringly committed itself.

Economists also warn that the Treasury guarantee system poses a risk of irrational price formations and hence a greater likelihood of burdens on the public budget. An equally grave problem is the lack of transparency around which projects will enjoy guarantees, as the regulation does not require the names of such projects be shared with the public, they note.

Recalling that the audit reports of the Court of Accounts are no longer brought to Parliament due to the government’s deliberate obstructions, Dr. Fatih Macit, a professor of economy at Istanbul’s suleyman Sah university, told sunday’s Zaman that this latest regulation only adds insult to injury for worries over the supervision and auditing of public expenditures and corruption. Macit argued that such a guarantee might be assessed as something good, because companies have sunk into serious financial troubles with the surging costs caused by a depreciating lira.

The lira has plummeted sharply in the last 11 months since the Fed announced a tapering of its bond-buying spree last May, rendering the financing of mega-projects such as the third airport in Istanbul, with a projected annual capacity of 150 million, a third bridge over the Bosporus, 15 city hospitals in 14 provinces and so on, extremely costly.

Inclusion of ongoing projects

The inclusion of tenders prior to the launch of the new guarantee system has also caused contention, with experts and businessmen demanding either the exclusion of the previous tenders or their renewal based on the latest changes for the sake of impartiality and transparency.

Economist Mahfi EGilmez, a former deputy undersecretary of the Treasury, has written an in-depth analysis about the issue on his personal blog. He said the guarantee the Treasury pledges itself to provide will have direct consequences for price formation in the tender process, which implies that tenders will be finalized with higher values to the benefit of the state.

This is, of course, an assumption reached under the expectation that all other conditions will remain unchanged. There are lots of variables that affect the price of a project or tender bids, such as the overall market conditions, political risks, changing risks of the participating companies, liquidity conditions in the domestic and international financial markets and so on.

That is to say, renewing the contract might equally result in lower project prices, given the worsening of the overall investment environment or the political situation of the country.

Economist uGur Gurses asked in his column in the Radikal daily whether the winners of the tenders deliberately offered higher bids to beat their rivals without prior knowledge that a guarantee would be provided. He postulated that one would expect relatively more companies to participate in the tenders for the projects and that the bids would be much more in favor of the state, had the companies known that their liabilities would be covered by the Treasury one way or another.

Gurses also draws attention to a bigger problem, the effects of which will be felt harder in the medium term. “Institutions are far more important than the political authority that formulates policies and executes them. These institutions that were created by the laws are being undermined.

The institutional infrastructure of fiscal discipline following [the economic crisis of] 2001 had been established through reforms that were based on these principles and laws. If the door is open now, that means the potential risks that might pass through this door have increased. This is exactly the case in the debt issue. Welcome back to the habits of the pre-2001 [era],” he noted.

There is another side to the story, relating to the burden these guarantees might create on the taxpayer. The regulation doesn’t specify any requirement for parliamentary approval for the money spent if the contracting companies default on their debts. Besides, there will be no mechanism to audit the money the Treasury pledges to provide in such a case. A Cabinet decision to take on the debts of these companies will not be published in the Official Gazette.

Harm to state very likely

EGilmez said it is unavoidable in the long run that the Treasury’s guarantee will cause an accumulation of state debt as lenders become unsatisfied with the production and purchasing guarantees. “If the risks increase in an economy, the area the Treasury guarantees in this economy is extended, too. This new regulation is a first step towards including the debts of the private sector entirely under the auspices of the Treasury. Before long, foreign lenders that provide loans to the private sector will start asking for Treasury guarantees outside this model [BOT] as well,” he wrote.