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Credit default swaps are a major indicator measuring country risks,
denoting the insurance premium on money invested in a country’s
government bonds. The higher the credit default swaps, the higher the
country risk.
According to economic sources such as Reuters and
Bloomberg,
Turkey’s credit default swaps reached 250 in October, the second
highest among emerging economies after Brazil with 266. South Africa is
third, almost neck and neck with Turkey, followed by Russia, whose risk
premium has been on the decline, falling to 218 in October.
Turkey’s risk premium has fluctuated over the years. When the global
financial crisis erupted in 2008, for instance, it shot up to 321, while
falling to 167 in 2010, when economic growth gathered steam. With the
recent
decline in economic growth, the risk premium has climbed up again, reaching the current level of 250.
Another widely monitored risk indicator is the grade
a country receives from credit rating agencies. Two of the top three
agencies watched by investors around the world —
Standard and Poor’s and
Moody’s — cut Turkey’s sovereign credit rating to non-investment grades in July and September respectively,
infuriating Ankara and leaving Fitch as the only major agency that keeps Turkey on investment grade.
Downgraded ratings especially sway the movement of “hot money” or
short-term investments in stock market shares and government bonds.
These types of external funds have become quite important for Turkey,
accounting for a portfolio investment stock of between $40 billion and
$42 billion.
Pension funds, in particular, heed closely the assessments
of credit rating agencies, pulling out from countries downgraded to
non-investment level. And indeed, the Turkish
Central Bank’s data points to net capital outflows in the wake of the latest downgrades.
The flight of foreign capital was then followed by the Turkish lira
tumbling against the dollar. The greenback, which traded for 2.94 liras
before the Moody’s move, has climbed up to 3.11 liras in the ensuing
weeks, and seems unlikely to retreat from these levels. Given the
country’s bulky external debt stock and the significant share of
short-term debt it includes, the appreciation of the dollar on such a
scale is not something the Turkish economy can easily digest.
For
indebted entities, a more expensive dollar means their debt has now
increased in terms of the Turkish lira. And when it comes to imports,
which amount to about $200 billion per year, the dollar’s appreciation
means an increasing cost for imported inputs, including machinery and
equipment, and thus a cost-push inflation.
In its 2017-19
medium-term economic program,
the government tacitly estimates the average dollar-lira parity for
2016 at 2.95, but the trend has already surpassed its projection in the
first 10 months of the year. The average parity stood at 2.93 in the
first half of the year, while reaching 3.00 in the second half so far. A
downward trend seems highly unlikely in November and December, meaning
the average for the whole year would be no less than 3.00.
This, in
turn, would equal to a yearly increase of nearly 10%, given that the
average parity was 2.73 in 2015. According to the program, the
government projects a consumer inflation rate of 7.5% for 2016, and if
this materializes, the increase in the dollar-lira parity would exceed
the inflation rate as well.
When it comes to economic growth, the program projects the rate at
3.2% for 2016 and 4.4% for 2017.
The target for next year depends
largely on the inflow of foreign capital, something that the program
itself admits by projecting that domestic savings would not exceed 13%
or 14% of gross domestic product, meaning that the funds needed for
investment could be secured only externally. And this brings up the key
question: Will the expected inflow of capital materialize? How will
Turkey attract foreign funds to stimulate growth while its risk premium
is on the rise, coupled with a “non-investment” grade by credit rating
agencies?
Turkey’s prevailing conditions and its prospects for 2017 signal
heightening rather than easing risks. Economic vulnerabilities are
growing, with only a 0.1% increase in investments this year. Atop the
investment drought, net external demand falls short of leveraging
growth, compounded by rapid declines in domestic demand, the result of
growing political and geopolitical risks affecting consumers.
Swelling housing stocks have caused particular concern, leading the government to
cut the value added tax
on housing sales by 10 percentage points last month at the expense of
losing budget revenues. Yet, the construction and housing sector — the
driving force of the economy in recent years — appears headed to new
bottlenecks in demand.
Rising geopolitical risks are an important factor driving the decline in domestic demand, the backbone of economic growth.
Turkey's interventions in Syria and
Iraq
have painted the picture of a country at war, deterring both foreign
tourists and investors. The turmoil in the Middle East and Ankara’s
ongoing confrontation with Kurdish actors both at home and abroad
represent a major component in the risk factor. The choice of a
security-based policy rather than dialogue and negotiations on the
Kurdish issue is, no doubt, pushing up the country risk.
In sum, the policies that manage the Turkish economy, already
relegated to the “non-investment” league, are bound to heighten rather
than lower the risk factors in the coming period. And a meaningful rate
hike by the US Federal Reserve in December would intensify the flight of
foreign capital from Turkey, further escalating the risks.
