Turkey faces painful path as firms’ risky debts grow

An ever-growing pile of corporate debt is exposing Turkey, among other major emerging markets, to external shocks while threatening macro-economic stability, market experts warn.

The Turkish central bank recently published figures on the country’s total foreign-held debt in the private sector, revealing some critical fragilities at a time of swift depreciation of the lira.

The long-term foreign debt owed by Turkey’s private sector totaled $156.8 billion in February 2013, $656 million higher than December’s figure, according to data released by Turkey’s central bank last week. Rising $11 billion from end-2013, the private-sector’s short-term foreign debt totaled $41.6 billion in February.

Observers stress that the private sector’s increasing debt is a new fault line threatening to become a long-term structural problem for the ailing Turkish economy. The lira’s slump, along with high debt levels, will result in an economic slowdown and rising unemployment, experts argue. This, they add, will also trigger an increase in Turkey’s current account deficit (CAD) and inflation, two major structural problems.

This fragile situation is exacerbated by a worsening global financial environment for heavily indebted emerging markets. Between late 2008 and last year, leading global lender the US Federal Reserve flooded the markets with cheap money under its quantitative easing policy. The Fed is expected to conclude its monthly bond-buying program later this year and most economists expect it to hike interest rates in the second half of 2015. This will have a negative effect on countries like Turkey, which depend on hot money at favorable interest rates to maintain economic growth, market experts warn.

On April 7, Turkish Central Bank Governor Erdem Başçı said there was no cause for concern about foreign debt rollover in the private sector, also ruling out repayment problems in the public sector. Two days later, the International Monetary Fund (IMF) said large debt piles at companies are rendering emerging economies more fragile because they could quickly put banking systems at risk in a crisis. “The share of weak firms after the shocks was the highest in Argentina, Turkey, India and Brazil, where they could account for more than half of all the firms,” the IMF said.

Regarding the sectoral distribution of long-term loans in the private sector in February, 54.7 percent of liabilities, or $85.7 billion, were owed by nonfinancial institutions. While 58.6 percent of the loans had been taken out by service-sector businesses, 40.9 percent of the loans went to the industrial sector. Only 0.5 percent of the loans went to the agriculture sector.

“Debt at risk of not being repaid by Turkish companies that have already borrowed heavily could increase remarkably and it will not be easy to overcome this problem in the short run,” economist Atilla Yeşilada told Sunday’s Zaman. “This shouldn’t trigger a large-scale economic crisis; however, we will have to learn to live with low growth and declining quality of life in the medium run.”

More than 80 percent of the foreign debt held by Turkish corporations is denominated in a foreign currency, according to a report published by investor services and credit rating agency Moody’s earlier in April.

The Turkish lira, while it has rebounded slightly in recent weeks, depreciated more than 30 percent against the euro from May 2013 to the first month of this year. The lira continued to plummet in the midst of serious corruption allegations that steadily trickled into the news after a graft probe went public on Dec. 17, 2013. In January, the central bank dramatically raised its overnight lending rate from 7.75 to 12 percent and its overnight borrowing rate from 3.5 to 8 percent in an effort to rescue the sinking lira.

Moody’s pointed out in its report that the central bank’s hike in interest rates might drive up the funding costs of Turkish corporations, thereby eating into their profits.

Observers say that central bank figures reveal that private firms depend too much on funding their business through long-term debt rather than deposits. Public institutions will not have a serious problem in repaying debts this year; the biggest burden falls on private businesses, especially in terms of long-term debts, economist Ercan Uygur told Sunday’s Zaman.

The current situation exposes a structural problem in the Turkish manufacturing industry — low productivity. It has long been thought in Turkey that private industry’s capabilities are limited to producing goods with high added value. These companies are also unable to make profits at a desired level.

“The debts firms take on board fails to contribute to their productivity and this has turned into a dangerous cycle, which is not sustainable in the long term,” Yeşilada argues. He says that real estate investment companies are an example of this; foreign debt goes directly to construction and infrastructure projects and these are investments with low productivity compared to such sectors as high-tech, medicine or IT.

“Turkey has failed to increase its total productivity in the last three years; investment plans are very short-sighted and this is not sustainable. Turkish companies have to boost their productivity but no one knows how. … There is no known roadmap for this,” Yeşilada adds.

Fed tapering, carry trade major external concerns

The US Fed had provided emerging markets with large sums in loans with low interest rates until the second half of last year and this served to boost emerging markets, Turkey among them.

There are fears that the Fed’s termination of this monetary stimulus policy will trigger capital flight in emerging markets and that this money will return to developed countries like the US where yields are high. Fed governor Janet Yellen has recently indicated that the Fed is in no hurry to raise interest rates.

The health of the labor market will most likely determine when the US central bank starts raising benchmark interest rates, which it has kept near zero since December 2008. “The negative effects on the availability of liquidity in global markets to Turkey remain the major problem. … Turkey’s fundamentals, however, are still stronger than some emerging market peers,” Yeşilada says. He adds that Turkey is still unlikely to suffer from a banking crisis, yet the problems will surface and become a long-term headache for the economy. “It will not be a banking crisis but rather a long-term problem in non-financial markets.”

“There will be an increase in bad loans and unemployment as well in Turkey. As the companies suffer a decline in profits, sacking employees might become inevitable, particularly in small and medium-sized enterprises (SMEs). More consumers may have difficulty in repaying consumer loans,” Yeşilada adds.

“It is not easy to see a decline in foreign debt especially considering that most companies who earn lira have to repay their debts in foreign currency,” Uygur added.

A possible decision by the Central Bank of Turkey to cut rates, as demanded by Prime Minister Recep Tayyip Erdogan, will have side effects on the entire economy, boosting CAD and inflation. This will see Turkey hit by the negative impact of a global liquidity dry-up even before the end of this year. “The million-dollar question here is for how long international creditors will continue lending to the Turkish private sector, ignoring the risks,” Yeşilada says.

Some observers have argued that Turkey may find some relief with hot-money inflow from Europe following an anticipated monetary easing by the European Central Bank (ECB). ECB President Mario Draghi has recently said that further strengthening of the euro could trigger more monetary easing, meaning an increase in the hot money available in world markets. However, Yeşilada said there will still be weak demand for European bonds.

Another prominent central bank that emerging markets have their eyes on is the Bank of Japan (BOJ). But this bank is also apparently awaiting decisions by the Fed. BOJ Governor Haruhiko Kuroda earlier said that the bank would adjust monetary policy when needed but said nothing to indicate that further easing steps would be forthcoming anytime soon.

“One critical issue is what will happen on the carry trade front,” Yeşilada adds. Earlier reports said that emerging economies, including Turkey, may suffer from a major meltdown in terms of borrow-low invest-high carry trades, through which an estimated $2 trillion has flooded, mainly into emerging debt markets in the past five years.

Earlier this month, Reuters reported that the latest cycle of carry trades is the third in little over two decades and its estimated size is roughly double that of its predecessor. “A reversal poses a specific risk to debt markets, especially in China, where investors who facilitated a corporate lending binge face both currency and credit losses,” the Reuters report said.

Emerging markets have seen carry trades fuel a boom-and-bust cycle before, the Reuters report said, adding that the first, driven by foreign banks, funded East Asian economic expansion before ending in 1997 with the Asian financial crisis. It said the second was the gigantic yen carry trade that built up in the early 2000s, during which an estimated $1 trillion poured into big emerging economies before a rapid unraveling in 2008.