While attention from the financial media only began to pick up late last week, the problems in Turkey have been piling up for many months. This is an economy saddled with just more than US$460-billion in external debt (mostly denominated in U.S. dollars and mostly in the corporate sector), equivalent to roughly 56 per cent of the country’s GDP. The current account deficit has ballooned to 6 per cent of GDP. Complicating matters further, President Recep Tayyip Erdogan’s insistence on low-interest-rate policy means the country’s central bank is abandoning any semblance of monetary orthodoxy – ensuring that inflation will spiral higher still.
What makes Turkey particularly vulnerable is that, 1), US$122-billion of this debt comes due within a year and 2), it has very little cushion in the form of foreign-currency reserves. This is a problematic mix that is very similar to what we saw in Thailand in 1997. The fact we don’t have a fixed-exchange regime in place now (as we did back then in most emerging-market countries) misses the point, because the 44-per-cent plunge in the Turkish lira isn’t that far off the decline (58 per cent) in the Thai baht that followed its devaluation just more than two decades ago.
Currently, the question in the market is whether or not there are knock-on effects from this that might morph into some sort of wider contagion.
A few points on this:
- Turkey is the 17th-largest economy in the world.
- In 1997, Thailand was the 30th.
- In 2011, Greece was the 33rd.
So, from a size/importance point of view, there is no reason to believe this shouldn’t have a meaningful impact on global markets. Turkey is the European Union’s fifth-largest market, so the coming economic downturn there is bound to exert negative feedback loops. Time will tell how this all plays out, but dismissing what is going on in Turkey because of its lack of size simply ignores what we know from history. It will be critical to monitor the extent of the spillover to other major emerging-market economies, because these countries have some pretty hefty debt burdens over the next five years.
Turkey has been a huge borrower in global capital markets when the world’s central banks were encouraging investors to stretch for yield. More than half of the borrowing is denominated in foreign currencies, so when the lira sinks, debt-servicing costs and default risks rise inexorably.
I think it pays to look at the Turkey situation in a certain global context. In the prolonged era of this cycle when the world’s major central banks were suppressing interest rates to absurdly low levels, in some cases negative, the consequence was excessive risk-taking. The term “TINA” was regularly used to justify endless inflows into the stock market – “There Is No Alternative”. But in the fixed-income market, there was an alternative, and it was referred to as the “Stretch for Yield.” It has to be understood that this is precisely what the monetary authorities desired in their quest to kick-start asset inflation as part of the drive to generate higher consumer inflation.
So when I say we have to look at Turkey in a global perspective, it’s only because there would have been no crucial issue had the country not gone wild on a debt spree over the past decade. But the same holds true for everyone on the planet. All we did, with the help of the central banks, was paper over one credit bubble with another one. There was no balance-sheet repair, in aggregate, this cycle. The world debt-to-GDP ratio is 244 per cent now compared with 210 per cent in 2007; the debt level outright is US$177-trillion now compared with US$112-trillion in 2007. Absolutely epic – the biggest debt-supported period of global economic growth on record. Nearly two-thirds of the global build-up of debt this cycle came from emerging markets – or what the legendary Don Coxe used to refer to as “markets you can’t emerge from in an emergency.”
Rare is the day that a credit problem shows up as an isolated event. Excessive leveraging has brought down empires in the past. The only thing poor Mexico and rich Orange County, Calif., had in common in 1994-95 was too much debt. The 1997 crisis started with Thailand, but it didn’t end there.
We saw this in the EU as well, where problems in Greece got resolved, but at the cost of cutting the economy down in size by 25 per cent, and in Italy today – where the looming budget fiasco will likely begin to dominate the headlines in the next month or two. Of course, in the United States, we have massive fiscal largesse now bumping against a record corporate debt load – to the point where more than half of the investment-grade market is rated BBB. The junkiest bond market of all time.
In Canada, and many other countries that experienced a housing bubble of unprecedented proportions, it is household debt that is the prime culprit.
But as for the emerging-market complex, the reality is that the boom in growth was yet another mirage. While Turkey obviously does have its own particular set of idiosyncratic political risks, the bottom line for all debtors is that the rates and liquidity cycle have turned. Against that backdrop, consider the cockroach theory and dig into which other emerging-market countries share similar debt dynamics – very high levels relative to GDP, high denominations in foreign currencies, challenging current account deficits, low foreign-currency reserves and looming large debt maturities. These would include South Africa, Brazil, Argentina, Indonesia, Mexico and Russia.
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.