Why the Turkish Debt Situation is Different?

In the latter half of 2018 as well as the early months of 2019, the newspapers were full of predictions regarding Turkish economic doom. To the average reader, the situation in Turkey seems no worse than the situation was in Greece or the PIIGS countries. Just like all the other countries, Turkey is poised to go into a deep recession. It is heavily indebted, and the price of its currency is continuously falling as compared to the Euro.

However, what makes the Turkish situations markedly different is the fact that it has been caused by private debt and not by government debt! Of course, that makes a bailout much more difficult. In this article, we will have a closer look at the Turkish debt situation and how is it likely to impact the European Union.

The Current Situation in Turkey

The Turkish financial problems are being caused by financial upheaval in the nation’s private financial sector. The private debt to GDP ratio of Turkey stands at an astounding 170%! The fact that more than 50% of the borrowing has been done in foreign currency only exacerbates the problem further. Since the Turkish lira has rapidly lost its value in the past year, Turkish businesses are having a hard time repaying the debt. The problem is so grave that Turkish businesses are not able to raise more debt to roll over previous debt. Close to $150 billion worth Turkish debt is about to come due in July 2019. At the present moment, corporations are finding it difficult to raise more cash and are likely to default on their obligations.

The overall economic situation in Turkey hasn’t been so good either. The currency has crashed by close to 40% in a single year. Rampant inflation is the norm and inflation numbers as high as 20% are expected. To make matters worse, the unemployment rate is also upwards of 15%, and in 2019, the economy is actually expected to contract further by 2%.

Private Debt

While understanding the Turkish crisis, one of the obvious questions that comes to mind is why did the Turkish corporations borrow so much money in the first place! The answers lie in the IMF austerity programs that Turkey had undergone in the early 2000.

Under the austerity clause of the bailout, the Turkish government was supposed to spend the minimum amount of tax revenue. Instead, other sources such as privatization of public resources were explored.

Hence, the Turkish government privatized some of its most prized possessions. However, the Turkish private sector i.e., the banks and the corporations, did not have the money to finance this privatization. This led to a borrowing binge.

The Turkish banks borrowed from the European banks. Later these borrowings were lent to Turkish private companies. In many cases, Turkish companies directly borrowed from European banks. This is the reason that so many of Turkey’s loans are denominated in foreign currency. Also, this is the reason that half of Turkish debt is held by private entities, whereas the other half is held by banks.

Links between Turkish Debt and Europe

The Turkish economy is not likely to go down alone. Instead, it is poised to create problems for the European economy as well. European banks are the most at risk from a Turkish default, which seems all but imminent now. For instance, most European banks were already in trouble. However, Spanish banks were also thought of as being financially stable. With Turkey’s debt woes, the financial vulnerability of Spain’s banks has also been exposed.

For instance, BBVA, which is the second largest bank in Spain, reportedly holds close to 50% of loans of Garanti bank, which is the largest bank in Turkey. The problem is that the non-performing loans of Garanti bank are also poised to rise, and hence the spillover effects of the same are likely to reach Spain as well.

The shares of other European banks like Unicredit and BNP Paribas have also been marked down by their investors because of their high exposures to risky Turkish loans. However, the blow to the stock price can only be considered to be minor damage. The real crisis will occur if Turkey enters a currency crisis, and defaults start rising all over Europe as well.

Turkish Crisis and Gold

Whenever paper currencies fail, people turn back to gold. This is exactly what is happening in Turkey, as well. Even though the prices of gold all over the world are falling, the prices of gold denominated in lira are at an all-time high.

The Turkish people have clearly ignored the pleas made by Turkish President Erdogan to sell gold and buy lira. In fact, the opposite is happening, and Turkey, as a nation, has seen as an eight-fold increase in the import of gold in order to meet the rising demand.

It is being speculated that the Turkish central bank is also building up reserves of gold which might come in handy if the situation were to worsen. This is bad news for the European banks since it seems like even the Turkish central bank is preparing for hyperinflation i.e., a situation where the value of the assets of European banks will be completely wiped out.

The bottom line is that the Turkish crisis is different. This is primarily because of the fact that the crisis will be caused by private borrowing instead of government borrowing.

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