Turkey’s debt-ridden Treasury mulls risky steps to stay afloat

The two main actors in the economic crisis gripping Turkey are the central bank, which runs the state’s monetary policies, and the Treasury, which is in charge of fiscal policies. The central bank is ostensibly independent, while the Treasury is attached to Treasury and Finance Minister Berat Albayrak, who is also President Recep Tayyip Erdogan’s son-in-law.

Those who follow how things work on the ground are well aware that the central bank does not act independently and is subject to direct and indirect government meddling. The bank has long felt compelled to seek Erdogan’s blessing in its interest rate decisions. Recently, it has come under pressure to let the Treasury use its resources and — again, at Albayrak’s behest — do something it should never do, namely directly or indirectly intervene in the foreign exchange market. The bank’s role in foreign currency sales by Treasury-controlled public banks, aimed at curbing the slump of the Turkish lira, is a case in point.

The central bank’s transfer of funds to the Treasury is even more intriguing. Such transfers are not something new — in fact, they are required by law, given that the bank is ultimately a state-owned company that transfers part of its profits to the Treasury. This year, however, the transfer that was due in April was brought forward to January via a legal amendment ahead of the March 31 local polls. As a result, the Treasury — saddled with major deficits due to the government’s preelection populism — was able to get early some 34 billion liras ($5.6 billion) instead of borrowing on high interest rates.

The Treasury has now reportedly set an eye on the central bank’s legal reserves, which represent 20% of its profits and a sum the bank sets aside by law to use in extraordinary circumstances. There are legal obstructions to the move, but given the government’s record on respect for the law, many are convinced it would not be discouraged by legal hurdles. Its only reservation seems to be that such a blood transfusion would lay bare the Treasury’s desperate situation for all to see, including the foreign money markets.

In fact, the Treasury’s gaping deficits and growing borrowing needs are already hard to conceal, no matter how much the figures are glossed over.

In the first four months of the year, budget expenditures were up 29% from the same period last year, according to Treasury and Finance Ministry figures. The increase exceeds the consumer inflation rate by 10 percentage points. In the sub-rubrics, the 51% increase in interest spending is particularly striking.

Budget revenues, comprised of tax and nontax revenues, were up only 19% in the same period. In other words, the increase in revenues was 10 percentage points less than the increase in spending and just kept up with inflation.

The contracting economy has also led to a decrease in revenues from indirect taxes levied on many consumption items. In the first four months, tax revenues grew only 6% in what was actually a significant decline in real terms, given the 19% inflation rate.

In stark contrast, nontax revenues increased 78% to 73 billion liras, making for more than a fourth of state revenues. The sum represents one-off revenues, including the nearly 34 billion liras in central bank profits transferred to the Treasury and money generated from paid exemptions from military service and an amnesty for illegal construction.

The extent to which tax revenues cover noninterest expenditures is an important fiscal indicator. In the first four months of the year, the coverage rate was 70%, down from 83.1% in the same period in 2018. Institutions such as the International Monetary Fund (IMF) are very mindful of that rate, and its decrease alone shows how debilitated the Treasury has become.

To tackle such budget woes, one looks either for a way to increase taxes or, as is more often the case, for new sources of nontax revenues, coupled with borrowing. For Turkey, the potential of nontax revenues is more or less exhausted, with almost no public assets left to privatize or sell off. This leaves borrowing as the sole option. Because of rising interest rates, fresh borrowing means increased interest expenditures in the budget. And when the government takes to the stage as a borrower, interest rates rise further. Growing interest expenditures eat into public spending in realms that bear upon lower and middle classes such as education, health care, social welfare and agricultural supports. As such, they come with serious political costs.

Budget deficits and a hefty public debt were the main problems in the severe economic crisis that Turkey experienced in 2001. According to IMF data, the budget deficit reached 12% of gross domestic product (GDP) that year, while public debt amounted to more than 76% of GDP. As a result of measures enacted under a standby deal with the IMF in 2001 and 2002 by the then-coalition government and, from 2003 onward, by the Justice and Development Party (AKP) — mostly the privatization of public entities — Turkey’s public deficit decreased to less than 1% of GDP by 2006, while public debt fell to 27% of GDP. Budget discipline became the key item in the AKP’s showcase as it sought to secure funds from foreign sources.

The economic woes since 2016, however, have led the AKP to use mostly the Treasury in managing the economy, including increased spending and tax exemptions in a series of election seasons. As a result, the budget deficit began to enlarge anew, reaching 3.6% of GDP in 2018. Public debt, meanwhile, is currently approaching 30% of GDP.

Fears are rife that budget gaps and public debt will continue to grow. The government going out to the market as a borrower could further upset the already fragile balances. Hence, Ankara’s quest for one-off revenues never ends. Now, it has gone as far as to consider a legal amendment to transfer the central bank’s legal reserves — a sum of about 40 billion liras ($6.6 billion) — to the Treasury.

Such a blood transfusion would not only deal an ultimate blow to the central bank’s claim at independence, but will also raise a huge risk of leaving the bank without a sail in some storm down the road. The intent for such a one-off funding operation, which lacks clarity on how much debt it could manage and for how long, is hardly flattering for the Treasury’s image. For Turkey’s foreign lenders, in particular, it is a reflection of how weak and vulnerable the Treasury has become. Still, the government is unlikely to give up on that money.