Turkey Pulse

Facing US sanctions, credit-fueled Turkish economy heads toward turbulence

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Article Summary
Through measures to free up capital flows, Turkey’s economy weathered the 2018 currency crisis, but analysts remain uncertain the nation’s markets can absorb more shocks as US sanctions loom.

Following a currency crisis sparked by US-Turkey tensions last year, the Turkish lira recovered much of its losses and remained fairly stable through 2019. Economic difficulties persisted with high unemployment, slow growth and grim news reports of families committing mass suicide due to their inability to pay off debts — but overall, Turkish markets proved more resilient than expected.

Now, as Washington lawmakers take steps toward imposing sanctions on Turkey for its acquisition of the Russian-made S-400 missile system and its recent Syria incursion, analysts remain uncertain the nation’s economy can sustain further instability in the year ahead.

“At times like this, small triggers may cause sharp fluctuations in financial markets and it is important to be cautious and develop right policies,” Selva Demiralp, an economics professor at Koc University, told Al-Monitor. “Sanctions may work as one such trigger.”

Demiralp said the Turkish economy is expected to end the year with a growth rate of about 0.5%. The burden of nonperforming loans on the private sector continues to weigh on economic recovery, and the issue remains unresolved, as monetary policy has largely focused on freeing up capital flows to stimulate spending and borrowing.

Since taking office in July, central bank head Murat Uysal cut Turkey’s benchmark interest rate four times by a total of 12 percentage points, unleashing a sharp 45% rise in consumer loan growth due to pent-up demand. Private sector loans grew 15% year on year during the same period.

Still, Demiralp said that while rate cuts lowered borrowing costs, they are also leading to increased risk perception and uncertainties.

“What the markets need to see is effective and transparent policymaking that is consistent with long-term objectives instead of short-term fixes,” Demiralp told Al-Monitor. “Absent that, we observe that weak confidence levels discourage consumption and investment, as suggested by the decline in investment and buildup of inventories.”

The focus on short-term fixes has come under increased scrutiny as the lira slid once again this week in response to mounting US-Turkey tensions. Turkey’s currency fell to its weakest level since May, at 5.94 liras per US dollar, after the US Congress passed a 2020 defense plan that calls for sanctions over Ankara’s S-400 purchase and bars the transfer of F-35 fighter jets to Turkey.

The lira, which lost 30% of its value against the dollar in 2018, is so far down 11% in 2019, making it the worst performing currency among emerging markets this month.

The impact of new US sanctions will depend on which legislation reaches the Senate floor, where Senate Majority Leader Mitch McConnell has previously expressed hesitation in sanctioning Turkey.

A sanctions bill was passed Dec. 11 by a Senate committee and is currently awaiting a full Senate vote, but some analysts believe markets have already “priced in” the risk of such measures, according to Wolf Piccoli, co-president and political risk analyst at Teneo Intelligence.

“The impact of sanctions, I wouldn’t say is negligible, but certainly something that Turkey can digest,” Piccoli told Al-Monitor, adding, “The real bite is already happening on the economic front. Being excluded from the F-35 consortium means $11-12 billion for the Turkish defense industry are gone.”

Piccoli continued, noting state meddling in monetary policy remains a top concern for international investors. Turkish President Recep Tayyip Erdogan has long maintained a stance against high interest rates, and the previous central bank governor was reportedly replaced this year for not supporting his views.

The most recent example of state interference materialized in Erdogan’s opposition to a bank bailout for the indebted Turkish fast food chain, Simit Sarayi.

The Simit Sarayi move “shows you one thing” Piccoli told Al-Monitor. “That we have a clear, direct, political interference in something that should be driven by the markets … these kinds of decisions should be taken by the banks.”

Reflecting on Turkey’s economic prospects in 2020, Piccoli said the outcome of the Halkbank case in the United States poses a significant threat to banking sector. Yet, overall, the impact of congressional sanctions would largely be determined by external factors and international market conditions at the time they are imposed.

“[Turkish regulators] will keep credit coming to prop up consumer demand in one way or another,” Piccoli told Al-Monitor, saying he didn’t expect any “meaningful reforms. They are not willing to acknowledge the real problems with the Turkish economy, meaning the corporate debt situation.”

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Diego Cupolo is a freelance journalist and photographer based in Istanbul, Turkey. His work has appeared in The Atlantic, The Financial Times, Foreign Policy and The New Statesman, among other publications. On Twitter: @diegocupolo

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