ISTANBUL: Turkey’s surging current account deficit makes the country more vulnerable to outside shocks, posing risks to investors amid doubts over the central bank’s efforts to contain it by letting the lira slide.
Economic expansion in Turkey typically brings a current account deficit in its wake but it is the speed at which the deficit has deteriorated and the reliance on short-term inflows of "hot money" rather than foreign direct investment to finance it, that have prompted alarm.
"If global capital markets were to be hit by some crisis and create a sudden stop in inflows, a major problem could result," said Robert C.
Shelburne, chief economist at the UN Economic Commission for Europe.
Consumer goods, made cheaper by a stronger lira, flooded into Turkey last year alongside energy and raw materials imports, sending the deficit shooting up from 2.3 percent of gross domestic product in 2009 to an estimated 6.2 percent, well in excess of a forecast 5.4 percent.
"If we did see an external shock the Turkish lira would collapse, imports would slump immediately and domestic demand would drop, halting
growth," said Mehmet Besimolgu, chief economist at Oyak Securities.
While the government expects the shortfall to ease to 5.4 percent of GDP in 2011, some economists say it is underestimating and forecast the deficit could top 7.0 percent.
"Turkey’s current account deficit has deteriorated faster than anywhere else in emerging Europe," said Manik Narain, analyst at UBS in London.
"There isn’t really a threshold regarding the size of the deficit at which investors would stop investing … but given where the deficit is now and given currency volatility they could be thinking twice."
In the interests of safeguarding financial stability the central bank embarked last month on a radical new policy of cutting interest rates to bring down yields and deter hot money.
At the same time, it raised required reserve ratios to balance inflationary effects and cool rampant credit growth, by forcing lenders to deposit more money with the central bank rather then dishing it out in cheap loans to consumers.
Since then the lira has fallen 5 percent against the dollar and 7.5 percent against the euro. Many analysts now see the lira depreciating to levels of 1.65 to the dollar from current levels of 1.58, with the blessing of the central bank.
While a weaker lira may curb import growth and revive exports it also carries a risk of higher inflation — potentially putting the brakes on Turkish growth, which is forecast at 4.5 percent in 2011 and 5 percent in 2012, and hitting Turkish asset prices.
The bank says the overall effect of its measures is "tightening" and reassures it sees inflation meeting its 2011 target of 5.5 percent. A survey of business leaders, however, shows expectations for year-end inflation at 6.61 percent.
"The bank is trying to achieve financial stability and low inflation and may be in the end it will achieve neither," said Narain.
"So far the lira weakening has been as a result of investors cutting long positions, but what we have yet to see is debt and equity market outflows which could be the next risk," he added.
Policy doubts
Ankara has surprised with its ability to keep borrowing in a tight spot before — not least when it shunned a new IMF stand-by loan in the depths of the 2009 economic crisis.
In fact, improved fiscal discipline, lower borrowing costs and a highly capitalized banking system have put Turkey within sight of an investment grade rating, which could come after a June general election if the government keeps spending tight.
If Turkey can sustain growth of 5 percent annually in the next few years and the current account deficit remains at around 5 percent of GDP over the same period, external debt should not get excessive, analysts say.
Central to the deficit outlook is the behavior of Turkey’s banks. What may prevent large-scale capital flight is the view that the commercial banks, which saw loan growth of 34 percent in 2010, are prudent, highly regulated and robust.
Unlike some emerging peers they are not run by troubled foreign parents — and issued most loans in local currency.
This stability should allow Turkey, an unsaturated banking market with huge demand for mortgages and loans, to absorb 2011 credit growth estimated at 25 percent without overheating.
Banks will also this year for the first time be able to issue Turkish lira bonds, tapping domestic funding.
"I’ve not seen in Turkey the excesses I’ve seen in other countries," said Marco Cravario, chief financial officer of Yapi Kredi Bank, Turkey’s fourth-largest lender by market value.
"Elsewhere banks were extending 10-year general purpose loans. Here the average maturity of general purpose loans is below three years."
The central bank hopes more moderate loan growth will sap consumer demand for foreign goods — and quell the trade gap.
Rising oil prices, rendered even more expensive by a weaker lira, could thwart any attempt to curb the deficit however, analysts say.
To retain sound investor confidence, Turkey will need a benign global backdrop and the kind of policy visibility some see lacking at the central bank.
"Right now it looks like their measures could just affect the lira rather than reverse the current account deficit," Besimolgu said. "We couldn’t understand what they are doing."
Turkish government bonds have been highly volatile this month — with the benchmark yield trading between 6.87 and 7.69 percent — amid confusion about whether the central bank would keep cutting interest rates and uncertainty last week about the size of another increase in reserve ratios which was not clarified until Monday.
Turkish equities meanwhile are starting to look pricey after rallying 27 percent last year as the economy grew around 8 percent, beating a 16 percent gain in the emerging stocks index.
Analysts say that to help maintain investor confidence the government needs to speed up longer-term structural projects which would help cut the current account deficit, such as building nuclear power stations to reduce energy imports.
"When the current account deficit reaches 6.2 percent you have to do everything right – you need a good framework, good policy predictability and the right policies," said Murat Ucer, an analyst with Global Source in Istanbul.
