Sharp contraction of the economy in the cards

Cases of covid-19 have been detected in Turkey, prompting the government to adopt multiple containment measures (social distancing, curfews, travel bans, quarantines, closures of schools, universities and stores, etc.). As a result of these local lockdown measures and the large external shock, a sharp contraction of the economic activity is in the cards. Despite the support measures, the IMF forecasts that real GDP growth will drop by 5% this year (cf. graph 1). Although a sharp recovery is expected in 2021, this projection is subject to great uncertainty, arising mainly from the evolution (duration and severity) of the covid-19 pandemic, which is very difficult to predict.

Fiscal and monetary support measures

The Turkish authorities have adopted key fiscal and monetary measures aimed at supporting the economy. On the fiscal side, the measures include raising minimum pensions and cash assistance to families in need, increasing employment protection by loosening the short-term work allowance rules, reducing or postponing taxes for affected industries (for instance in the tourism sector), a ban on layoffs (initially for three months, with a state subsidy for affected staff), state payment of two thirds of the salaries of workers employed in affected firms, debt relief for local governments’ earmarked revenues, direct support to Turkish Airlines and other affected entities, and the Turkey Wealth Fund being given new rights to buy stakes in distressed firms. On the monetary front, the Central Bank drastically reduced its policy rate from 12% at the end of December 2019 to 8.75% (latest cut on 23 April) and introduced other measures to support credit, such as lower reserves requirements and broader pool of assets eligible as collateral in CBRT transactions. This drastic interest rate cut implies that the real policy rate is now negative as the inflation rate reached 11.86% in March 2020. In this regard, it is worth to note that the independence of the Central Bank has been in doubt for years. The last moves from the Central Bank – while positive in terms of support for the economy – reflect again that its independence is questionable.

Current account surplus reduces external pressure to some extent

Even if the current account receipts are relatively well diversified, the external shock hits the balance of payments hard. Indeed, tourism is one of Turkey’s key sectors – accounting for about 10% of current account receipts in 2018 – and is suffering badly from the covid-19 crisis. Moreover, real GDP growth in the European Union (Turkey’s main trade partner, as it is the destination of almost 50% of the country’s good exports) is expected to decrease sharply this year (by 7.1%), which would put pressure on Turkey’s goods exports. As a result, current account receipts are expected to drop this year. On the positive side, Turkey being a large oil importer, the sharp drop in oil prices is a very good news for the country. All in all, the current account balance is expected to be in surplus this year for the second consecutive year in a row, a three-decade record (cf. graph 2).

The unprecedented, sudden and sharp reversal of capital flows hits the Turkish economy hard, as it relies heavily on volatile capital flows to finance its large external obligations (short-term external debt, debt service and current account deficit, if any). These obligations have decreased recently as the current account balance is in surplus after having been in deficit in the past. The debt service is still moderate and broadly stable. Turkey’s main Achilles’ heel remains its huge short-term external debt (more than two times the gross foreign exchange reserves) combined with its relatively low gross foreign exchange reserves which have been under severe pressure recently (cf. graph 3).

The Turkish lira is under renewed pressure

The sharp depreciation of the Turkish lira (TRY) relative to the USD is a source of concern. Indeed, a large share of the private corporate debt – estimated at 80% of GDP following recent and welcomed deleveraging – is denominated in foreign currency and is therefore more costly to reimburse in local currency terms when the exchange rate depreciates. On the positive side, this debt is largely domestic and financed by the banking sector. This, along with the sharp contraction of the economic activity, is likely to push more companies in difficulties and thus to deteriorate further the asset quality of the banking sector (NPL stood at 5.2% in February, up from 3.9% at the end of 2018), which relies heavily on external funding and is hence already affected by the sharp deterioration of the global financial conditions.

To end on a positive note, one of the strengths of the Turkish economy remains the sound finances of its central government, which provide the country with sufficient fiscal space to support the economy during this difficult period. That being said, the figures on other public entities are not available but still represent contingent liabilities (along with the banking sector).
 
Analyst: Pascaline della Faille - P.dellaFaille@credendo.com