Turkey’s currency crisis is now as plain as the nose on the finance minister’s face but how long before officials have to acknowledge the fact that the country is also mired in a debt crisis in something like a replay of the 1997 Asian financial crisis?

As the Turkish lira (TRY) plunged another 16% on August 10, beads of sweat must have been breaking out on the brows of anyone unduly exposed to the latest data on Turkey’s foreign currency debts.

bne IntelliNews warned back in October last year that storm clouds were gathering over the Turkish economy and, with an eye on how analysts in Turkey have come to fear for their jobs under strongman President Recep Tayyip Erdogan’s regime should they stick their necks out with ‘too much’ bad economic news, in early April we published a comment piece headlined: “Whisper it—‘Erdonomics’ could be driving Turkey to a meltdown.”

One analyst who certainly wasn’t speaking in hushed tones on August 11 was Win Thin at Brown Brothers Harriman & Co. in New York. He told Bloomberg: “This is a textbook currency crisis that’s morphing into a debt and liquidity crisis due to policy mistakes.”

He added: “The way things are going, markets need to be prepared for a hard landing in the economy, corporate defaults on foreign currency debt, and possible bank failures.”

According to central bank data, Turkey’s non-financial companies’ foreign currency liabilities now exceed their foreign exchange assets by more than $200bn. In the next 12 months alone, private non-financial institutions must repay or roll over $66bn in foreign currency debt. Turkey’s banks, meanwhile, face a figure of $76bn.  In all, private companies in Turkey sit on a pile of debt equivalent to about 40% of GDP and in the past year several of the country’s biggest respected conglomerates have requested restructurings of billions of dollars in foreign debt.

The anxieties are mounting fast. An ABN Amro report released on August 9 outlined how investors are worried that Turkey will be unable to finance its annual external financing requirement of around $218bn, a sum which includes funds needed to maintain Turkish companies’ foreign-denominated debt as well as the country’s hefty current account deficit, one of the widest in the world at about 5% of GDP. The base case scenario remained that Turkey would raise sufficient funds, the report added, while noting that “rumours about possible capital controls on forex transfers and IMF assistance have further fuelled stress in the foreign exchange market”.

A big difficulty for Turkey is that its debt-driven economy has since the 2008 financial crisis been much built on short-term foreign funds. Given the ultra-loose monetary policy in the US and Europe and the giant asset purchase schemes stemming from US and eurozone quantitative easing, investors were moved to seek higher returns in Turkey and other emerging markets. But tightening is now under way in the US and other developed economies, while QE is being wound down, meaning Turkey’s search for the funds it requires is becoming very much harder.

Deep breath
Those taking stock of the decline of the lira require a deep breath. Now the world’s worst performing major currency of 2018, it was in the early hours of August 12 down around 40% in the year to date at 6.4300 to the dollar. Staggering as it is to remember, in 2014 a dollar purchased just TRY2. Also sobering is the fact that the modern lira’s biggest ever slump was a 36% drop over roughly six weeks at the height of the financial crisis a decade ago. The current year-to-date descent reached as much as 46% during the rout on August 10 before losses were modestly trimmed.

Market observers contemplating a full-blown debt crisis breaking out in Turkey know the lousy state of the lira has already set off plenty of alarm bells given that over a third of domestic lending in the country is in foreign currencies and the businesses of creditors are clearly largely running off local currency revenues.

The vulnerability of the banking system is palpable. Banking shares slid 6.4% on the Istanbul stock exchange on August 10, taking their decline this year to 37%. Slowing growth, rising bad loans and higher interest rates stand in their path.

“Where to watch”
On August 10, Capital Economics put out a note entitled “Where to watch for signs of stress in Turkey’s banks?”

“Banks’ dollar bonds yields and interbank interest rates are already pointing towards some stress, and these will be key indicators to watch over the coming days and weeks,” wrote William Jackson, chief emerging markets economist at Capital.

At the time Jackson was compiling his note, the TRY was 14% down day on day against the dollar, prompting the economist to say: “For what it’s worth, when the Russian ruble fell by a similar amount in a single day during the crisis in 2014, Russia’s central bank hiked its policy rate by 650bp. It also announced measures to support the banking sector, including providing more foreign currency liquidity, tweaks to accounting rules to help banks deal with the impact of a weaker ruble on their balance sheets, and recapitalisations.

“Investors are clearly concerned that Turkey’s government won’t act (or allow the central bank to act) to shore up the currency, and fears are mounting that this could result in a crisis in Turkey’s banking sector. After all, over a third of domestic lending is in foreign currencies, and banks have substantial short-term external debt.”

Historically, one of the best predictors of stress in the banking sector is to look at whether interbank interest rates spike above the central bank’s interest rate, Jackson added. It was notable, he said, that interbank rates ticked up by 25bp on August 10.  “This could be because the fall in asset prices has reduced the collateral available for interbank lending. Another possible explanation is that banks have restricted lending to others due to fears about counterparty risk. We wouldn’t read too much into a relatively small move that occurred in just one day, but if this continued it might be an alarming sign that the interbank market is freezing up,” Jackson noted.

Looking at early signs of stress in the banks’ dollar bond yields, he concluded: “One possibility is that investors have become concerned that US sanctions could expand to include the banking sector, adding a premium to the yield on Turkish banks’ bonds. However, it also seems plausible that investors are worried that the fall in the lira will make it more difficult for banks to repay their large external debts. If banks’ external borrowing costs continue to rise, a severe credit crunch will become all the more likely.”

Erdogan unleashes another volley of hot rhetoric
Time to hand over to the technocrats and the central bank for a whacking great interest rate hike you might think. But such hopes looked forlorn in the wake of the populist Erdogan’s latest volley of hot rhetoric unleashed at actors in the West whom the president accuses of having brought Turkey to the brink.

“We are aware that the issue is not the dollar, euro, gold... these are the bullets, cannon balls, missiles of the war started against us,” said Erdogan. “We have taken and will continue to take necessary measures to respond. But what’s important is to break the hands that fire these weapons.”