Emerging markets will soon find themselves operating in a new world order. Few people are as painfully aware of this as Turkey’s Deputy Premier Ali Babacan.
A soft-spoken politician whose key positions in three successive Justice and Development Party (AKP) governments included a two-year stint as foreign minister, Babacan is currently the highest-ranking cabinet member responsible for the economy.
Needless to say, he was all ears when US Federal Reserve Chairman Ben Bernanke suggested on May 22 before the US Congress that it could begin to downsize its $85 billion-per-month bond-buying program.
Babacan had seen that coming. He warned Turkey repeatedly against overspending in 2012 — even at the risk of displeasing Prime Minister Recep Tayyip Erdogan — because he knew cheap loans would soon grow scarce.
Indeed, the United States is getting ready to curtail the stimulus that has injected cash into emerging markets for the last four years. Stocks plummeted at the news and national currencies fell against the dollar, with India, Brazil and Turkey all registering substantial losses.
Still, answering questions on live television on May 23, Babacan was as cool-headed as ever. First, he reminded the viewers that the European Central Bank and Bank of Japan would follow suit, thus making the impact of the Fed’s exit even stronger on Turkey. Then he said, “If they carry out these operations in an orderly and coordinated fashion, we will ride it out.”
As Babacan would surely have known, that is a big if. Despite a recent call for coordination by the International Monetary Fund’s managing director, Christine Lagarde, sell-offs in emerging markets do not seem to be a major concern for the architects of the taper plan.
“We only have a mandate to concern ourselves with the interest of the United States,” Dennis Lockhart, president of the Atlanta Fed, told Bloomberg TV. “Other countries simply have to take that as a reality and adjust to us if that’s something important for their economies.”
In fact, adjustment is not a question of choice here. Emerging economies will have to find a way to continue funding growth and paying off debt without the liquidity infusion. It won’t be easy.
The looming exodus of cash and higher borrowing costs have already caused permanent damage in Turkey. The lira weakened dramatically on Aug. 23, with the dollar surpassing two liras for the first time in history. Turkey’s Central Bank dipped into its reserves, but a $350 million sale of foreign exchange reserves failed to calm the market.
Babacan, for his part, has been referring to Bernanke’s May 22 speech as a turning point. The global economic crisis has entered a new phase since that day, he said. “We’ll all see the spillover effects and new faces of the crisis in the coming months.”
He did not stop there. In his signature straight-shooting manner, he also signaled a downward revision. “It should not be surprising for Turkey to revise its growth rate below 4%. … We set our annual exports target at $158 million, but it looks difficult to reach this target as well.”
A politician who seldom walks and talks like a politician, Babacan has been a maverick of sorts in the government. He entered politics in 2001 when he joined Erdogan and others to found the AKP. At the time, he was a 34-year-old with a degree from the Kellogg School of Management and work experience as a financial consultant in Chicago. In 2002, he was appointed the state minister for economy and became the youngest member of the cabinet.
Today, Babacan still has the boyish looks that earned him the nickname “baby face,” and he still exhibits a distaste for populism.
The most significant feature of Turkey’s recent economic success is fiscal discipline, and no one in the government has been a stronger supporter of that than Babacan.
Around this time last year, when a fellow cabinet member, Economy Minister Zafer Caglayan — equally hardworking, yet keener on instant gratification — criticized the Central Bank’s tight monetary policy, Babacan slammed him.
“We do not have the luxury of pressing the brakes,” Caglayan had said. Babacan’s response: “In foggy weather, the driver should not listen to those telling him to press the gas pedal.”
In what came to be known as the "gas-break dispute,” Erdogan threw his weight behind Caglayan and criticized the statutorily independent Central Bank for keeping interest rates too high.
Last week, the Central Bank hiked its overnight lending rate for the second month in a row by 50 basis points to 7.75%. Erdogan and Caglayan watched quietly this time, hoping the raise would help prevent the lira from sliding further. It did not.
As Babacan’s proverbial fog is slowly lifting to reveal a slippery slope, I can’t help but wonder if he feels vindicated by the turn of events. Probably not, since the risk that awaits Turkey now is worse than a taper tantrum, and Babacan must know just how bad it can get.
The Fed’s decision exposed Turkey’s vulnerability. Described by economist Erinc Yeldan as “a gradually deflating balloon, subject to erratic and irregular whims of the markets,” Turkey’s speculative growth over the last four years has been financed by running a large current account deficit, which in turn was funded with hot money that is no longer readily available.
As Standard Bank analyst Timothy Ash pointed out last week, “It is a bit hard to recommend [buying the lira or entering] bond positions while inflation remains elevated, and the current account is still supersized at $55-60 billion, with that huge external financing requirement.”
Estimated at $205 billion, or a quarter of Turkey’s gross domestic product (GDP), the external financing requirement is huge, indeed.
“A more extreme measure of vulnerability would add the $140 billion of foreign-held bonds and shares,” Hugo Dixon wrote in his Reuters blog. “If this tries to flee, the lira could plunge.”
Babacan admits that “Turkey might feel the negative effects of the Fed’s policy shift a bit higher than others … due to our already higher current account deficit.”
Turkey’s reliance on hot money to turn over its short-term external debt, which has been increasing more rapidly than the national income, is only the tip of the iceberg. What makes Turkey’s robust growth rates of 9% in 2010 and 8.5% in 2011 unrepeatable might be the disappearance of cheap loans. However, the real reason behind the unsustainability of such growth is structural.
From insufficient capital accumulation and a low savings ratio to poor labor efficiency, the Turkish economy suffers chronic ills that can only be cured through radical reforms, including a major overhaul of the education system.
Again, Babacan knows it. Earlier this year, he commented on the government’s plan to increase the GDP per capita to $25,000 in 2023 by pointing out an anomaly:
“No other country in the world with an average education of only 6.5 years has a per capita income of $10,500. And no country with such an education level ever had an average income of $25,000. Without solving our education problem, our 2023 targets will remain a dream.”
Some say ignorance is bliss. Listening to Babacan makes me think they may be right. After 11 years, being part of a government that failed to do what you know should have been done cannot be much fun.
Yasemin Çongar is the author of four books in Turkish, among them Artık Sır Değil (No More A Secret), a detailed analysis of the US diplomatic cables on Turkey first made public by WikiLeaks. A former Washington bureau chief for Milliyet (1995–2007) and a founding deputy editor-in-chief of Taraf (2007–2012), Çongar is currently based in Istanbul and is a columnist for the Internet newspaper T24.