Markets have turned against Turkey, as they see an escalating spat between the country’s authoritarian President Erdogan and US President Trump derail a credit-fuelled economy. Risky Finance has prepared six charts that illustrate the severity of Turkey’s problems.
The Turkish Lira has declined precipitously against the dollar, more than any other currency, including the Argentine peso. The currency weakened by 45% since the start of the year, and 60% since the end of 2015. If it persists, this decline will have serious consequences for Turkey.
To investigate this, we use the Risky Finance sovereign tool, which shows iBoxx data for Turkish sovereign and quasi-sovereign debt. There is $120 billion outstanding of this liquid debt, $55 billion of which is in external currency, mostly dollars. A more interesting way to view this is to compare the exposure with other countries, scaled as a percentage of gross domestic product.
Which GDP figure do we use? We start with the dollar current prices GDP published by the International Monetary fund in April. iBoxx debt accounts for 14% of Turkish GDP, a fairly modest amount compared with other non-investment grade EM sovereigns.
Next we take the IMF’s April local currency GDP, and convert to dollars using the 13 August exchange rate. This time the ratio of iBoxx debt to GDP stands at 23%, making Turkey stand out much more against other EM issuers. Clearly the decline in Turkey’s currency is making its sovereign debt much less sustainable.
Investors have reacted by selling the bonds, and this can be seen by the cluster of red squares for Turkey in the previous chart. To get a closer look, consider the yield curve plot below. This chart combines local currency bonds with foreign currency debt, comparing yields on 10 August (green dots) with those at the start of the year (pink dots).
The local bonds are clustered at the shorter maturities and have higher yields to reflect the currency risk and inflation risk for non-Turkish investors. Their yields have risen to as high as 25%, double the amount at the end of 2017. The foreign currency bonds yielded around 5% at the start of the year, and now yield twice that.
One reason that markets are so intolerant of Turkey is because of its financing requirements. Following the IMF’s methodology, we add maturing debt and interest coupons to the forecast current account deficit to show the country’s so-called gross refinancing requirement (GFR).
For Turkey, this refinancing requirement is about $50-60 billion annually for the next five years (the maximum horizon for IMF current account forecasts). If we express that as a percentage of GDP (converted from local currency at the 13 August exchange rate), then Turkey has to refinance more than 12% per year, putting the country in the top bracket for emerging market sovereigns, along with Brazil. Then again, Brazil has a proportionately much lower foreign currency debt burden.
Turkey’s problems don’t stem only from sovereign borrowing. The country’s private sector has also borrowed heavily in recent years. The Risky Finance corporate debt tool displays $35 billion of foreign currency borrowing (in USD, EUR and GBP) tracked by iBoxx. The chart shows bonds in red and equity market cap in pink.
The lion’s share of the debt is bank borrowing, led by domestic players such as Turkiye Is Bankasi, Yapi ve Kredi Bankasi, and Garanti Bankasi. These three banks and others in the sector have seen their share prices hammered such that their market caps are now less than half of their outstanding foreign currency debt.
With earnings denominated in Turkish lira, the ten banks tracked by iBoxx will have to collectively pay about $5 billion annually in hard currency principal repayments and bond coupons in the next five years. Some may face questions about their solvency, even though Turkey’s politically-controlled central bank has pledged to provide liquidity.
This takes us to our final chart, which shows credit exposures of EU banks to Turkey compiled by the European Banking Authority in June 2017. This totals €35 billion, led by BBVA and Unicredit. These banks take their exposure in the form of controlling equity stakes in Turkish banks, which Basel rules require to be treated as credit exposure.
The rationale for that is that banks are likely to bail out these investments rather than walk away and benefit from shareholder limited liability. A full-fledged Turkish banking crisis will test this rationale to the limit.