Not long ago, everyone was worrying about the Turkish economy overheating. It grew by almost 9% year-on-year in the second quarter. Credit growth was rocketing, hitting an annual pace of around 40%. That fuelled a spending boom on imports, which drove the current account deficit to unprecedented levels: it has averaged 9% of GDP over the past year.
A current account deficit means a country is in debt to the rest of the world, and has to borrow from abroad to fund growth. That leaves it vulnerable to changes in external borrowing conditions and investor sentiment, says Capital Economics. The risk is that capital flows dry up, causing domestic demand to crumble and sending the economy into recession.
This is a particular danger if, as in Turkey’s case, the current-account shortfall is being plugged to a large extent with short-term capital flows (investments in stocks and bonds, for instance) rather than more stable, long-term flows such as foreign direct investment in companies. Such short-term capital – or ‘hot’ money – can leave a country very quickly if risk appetite falters. The problem is, it looks as though a sharp slowdown, which could end in recession, is taking place.
In the two months to 23 September $4bn flowed out of equities and bonds – the biggest outflow through these channels since 2008, says Capital Economics. Loan growth has fallen so sharply recently that it is pointing to consumption falling.
By cutting banks’ reserve requirements last week (to encourage more lending) while at the same time intervening to prop up the currency (to deter capital flight), the central bank has clearly decided that pre-empting a downturn is more important than preventing overheating.
Analysts who have been warning for some time that Turkey could face a hard landing, including those at Capital Economics and Standard & Poor’s, now look prescient. With global risk appetite unlikely to improve as the developed world’s economic prospects look bleak, more capital seems likely to leave the country, so the economy and stockmarket face a turbulent few months. This hasn’t yet been priced in to stocks: the stockmarket’s valuation is still around the ten-year average. So further falls in Turkey’s benchmark ISE index seem likely.