Turkey’s Shaky Foundations: Structural Deficit Underpinned by Volatile Capital Inflows
April 27, 2011
By David Rogovic
In 2009, at the height of the global financial crisis, a reduction in capital inflows and domestic demand caused a narrowing of external imbalances across emerging Europe. Now, as the region returns to positive growth and recovers from the crisis, Turkey stands out in terms of the size and speed at which its current account deficit (CAD) is expected to grow. This is due in part to a more rapid recovery, but also to a shortfall of domestic savings relative to investment. While a large CAD is nothing new for Turkey, the country is more reliant now than in previous episodes on short-term and historically more volatile foreign capital to finance the deficit. These twin external vulnerabilities—a large CAD and less stable quality of financing—leave Turkey susceptible to shifts in investor confidence and/or global liquidity. In a worst-case scenario, the volatility of capital inflows could lead to credit busts and severe downturns.
Turkey’s history shows a clear pattern of above-trend GDP growth associated with a widening CAD, only to be reversed by a slowdown or contraction in real output. Turkey’s CAD reached an all-time high (6.6% of GDP) last year as its domestically driven recovery increased demand for imported goods.
Precrisis, Turkey’s CAD represented a smaller share of GDP compared to some peers, such as Romania and Hungary, raising concerns about the sustainability of Turkey’s current growth, which has been accompanied by a major credit expansion and signs of overheating. In 2011, even as Turkish growth moderates, structural factors along with rising oil prices threaten to drive the CAD toward 8% of GDP, or more than US$60 billion.
Not only is Turkey’s CAD expected to remain large over the next few years, but the quality of external financing is now more volatile and prone to reversal. Compared with the precrisis years, external financing is more reliant on debt-generating portfolio investment and capital intermediated by the local banking system. FDI, generally considered a more stable funding source, is only slowly recovering and remains well below precrisis levels. In 2010, FDI inflows represented 1% of GDP, compared with 3.6% of GDP in 2006. At the same time, Turkey’s CAD is larger today than in 2006—net FDI covered almost 60% of Turkey’s external financing needs in 2006, compared with 15% in 2010.
Portfolio and other investments have filled the shortfall. By late 2010, portfolio and other investment inflows had exceeded precrisis highs, while total capital flows had not reached precrisis levels.
Even within portfolio and other investments, there are stark differences in the quality and reliability of the funding. Equity portfolio inflows generally display more stability than the debt-generating kind—which have dominated the surge in overall portfolio flows into Turkey since mid-2009. These inflows also generally have shorter maturities compared with FDI, which may lead to excessive currency appreciation.
Although net portfolio investment inflows have slowed somewhat in recent months, expectations of monetary policy tightening in H2 2011 will increase Turkish interest rates, potentially attracting speculative flows.
Other investment inflows now cover nearly 70% of Turkey’s CAD, roughly equal to 4.5% of GDP (on a 12-month rolling basis). The increase has been almost entirely driven by a rise in foreign currency and bank deposits and short-term loans to banks. The resulting rise in domestic liquidity has facilitated a domestic credit boom and is a key reason behind the Turkish central bank’s (CBT) unorthodox monetary policy in late 2010 and early 2011. Given the relatively shallow financial system, excessive capital inflows can lead to excessive credit growth, asset bubbles and banking-sector crises down the line. Whether the CBT is able to effectively extend the maturity of banking-sector liabilities and rein in credit growth is yet to be determined.
Likewise, whether the recent surge in capital inflows reverses and proves destabilizing is an open question. Turkey’s rapid recovery from the 2008-09 slump has proved the economy is more resilient than in the past, and capital inflows may enhance its long-term growth prospects. On the other hand, Turkey’s history, and those of other emerging markets, show that capital flows can rapidly reverse, and suggest careful evaluation of structural weaknesses.
0 comments:
Publicar un comentario