- In the four days of trading since the failed military coup the Turkish lira has weakened significantly and share prices have tumbled.
- The Central Bank of Turkey and the Treasury have been in the front line to reassure investors that the government’s uncompromising response will not affect the economy.
- Perceptions of instability in Turkey will further discourage travel to the country, exacerbating the crisis in the tourism sector, and will delay or deter domestic and foreign fixed and financial investment.
- The context of loose global liquidity conditions provides some breathing space to allow Turkey to continue to meet its substantial external financing needs while the authorities restore stability and confidence.
- However, the extent of the purge of the state institutions to root out those suspected of supporting the coup attempt raises concerns that the mood could spread into the economic policymaking sphere, a move that could inflict irreparable damage on institutional capacity.
- Some 1,500 officials of the Ministry of Finance have been dismissed, but the Central Bank and the Undersecretariat of Treasury have as yet been unaffected. If this were to change, investor nervousness could rapidly escalate into a wholesale sell-off of Turkish assets.
In the days following the failed military coup of July 15th day-to-day economic activity appeared to return to normal quite quickly. There have been no queues at banks, utilities and public transport have continued to function, shops re-opened as soon as the violence ended, refuse was collected and airports gradually resumed normal services. However, the unexpected coup attempt and the extent of the government’s response, which includes a declaration of a three-month state of emergency, have increased uncertainty about the political and economic outlook for Turkey at a time of already heightened instability. As a result, financial market nervousness has risen—although, given the gravity of events, not by as much as might have been expected. The lira, which was trading at about TL2.88:US$1 before the attempted coup, stood at TL3.08:US$1 on July 21st. In the four days of trading between July 18th and July 21st share prices on the Borsa Istanbul fell by 9.6%, reversing all of the gains accumulated in a rally that had begun in mid-June. Meanwhile, the yield on the benchmark two-year government bond backed up by about 100 basis points, to 9.6%.
Increased risk to the economy
The nervous reaction of the financial markets signals that the failed coup attempt and its aftermath might affect the economy more in the months ahead than is immediately apparent. On July 18th, when trading resumed after the coup, Turkish Airlines shares fell by 12.5%. Istanbul’s main airport, which was closed as a result of the failed coup but has since reopened, has now been brought to a standstill twice in a matter of weeks. Before the coup attempt the numbers of foreign visitors to Turkey had already plummeted, hit severely this year by Russian sanctions (although these are now being lifted) and the effect of repeated terrorist incidents. The attempted coup could cause the fall in tourist arrivals to deepen, dampening economic growth and pushing up unemployment. The tourism sector’s direct contribution to the economy amounts to 4.5-5% of GDP (about 12% including the indirect impact) and accounts for about 2.5% of employment (about 8% in total).
Turkey’s investment risk profile has suffered too. The economy depends heavily on continued inflows of foreign capital to finance its perennially large current-account deficit, currently running at about 4.5% of GDP, and to service a foreign debt stock—mainly owed by the private sector—which rose to US$411.5bn, or about 58% of GDP, at the end of the first quarter of 2016. Short-term external debt was about US$100bn in the same period.
Central Bank and Treasury seek to reassure investors
In the uncertainty created by the failed coup Mehmet Simsek, the deputy prime minister responsible for economic affairs, and the Central Bank of Turkey, headed by the governor, Murat Cetinkaya, have sought to reassure investors that the government has regained control of the situation, that it will not over-reach in its response to root out the perpetrators as it seeks to restore stability and that the economy will not be negatively affected. On July 17th, as the last of the rebels were being disarmed, the Central Bank announced a series of precautions to ensure the continued effective functioning of the banking system, including a promise of unlimited liquidity to banks in need. On July 19th the Monetary Policy Committee (MPC) of the Central Bank continued its recent round of interest rate cuts, reducing the overnight lending rate, which marks the upper bound of its interest rate corridor, by a further 25 basis points, to 8.75%. The bank has now reduced the corridor ceiling by a total of 200 basis points since March.
Previous rate cuts were partly a response to political pressure, even if the MPC insists that its monetary policy stance remains “tight” and that the cuts are part of a normalisation process of narrowing the interest rate corridor with a view to restoring a single policy rate. The decision to cut rates by only 25 basis points rather than the 50 announced at the previous three MPC meetings may have reflected the bank’s caution following the failed coup, the uptick in the annual rate of consumer price inflation to 7.6% in June or the fact that the space for rate cuts is narrowing. In its statement the MPC noted the financial market fluctuations triggered by the coup attempt and warned separately of a likely increase in inflation in the short term.
Loose global liquidity provides some breathing space
Fortunately, US interest rate rises are currently on hold and global liquidity conditions remain loose. In these circumstances Turkey has been having little difficulty in attracting the capital inflows it needs to avoid currency weakness, higher inflation and a decline in economic activity. We expect that these global conditions will prevail for most of the year, affording Turkey some breathing space while the authorities restore stability and confidence.
Even so, credit growth is likely to remain slow and fixed investment to go on stagnating. The exchange rate will be softer than it would have been without the coup attempt and is likely to remain above the TL3:US$1 mark, at least in the short term. This situation will maintain inflationary pressure. As a result, the Central Bank might have to limit itself to one more 25-basis-point cut in the overnight lending rate—unless the government insists irresponsibly on more. Combined with the hit to tourism and capital inflows, we are likely to lower slightly our current forecast for real GDP growth of 3.5% in 2016 and 3.8% in 2017—down from 4% in 2015—but with an increased risk of much greater disruption to the economy.
Economic management and reform at risk
A major concern for investors is the medium-term impact on economic policy and reform prospects of the attempted coup and the government’s response. The purge of the state institutions to root out those suspected of supporting the coup attempt has spread from the military, the police and judiciary to the education sector. The dismissal of some 1,500 officials at the Ministry of Finance has raised concerns about the day-to-day management of the public finances at a time when the central government budget deficit looks set to exceed significantly the government’s target of 1.3% of GDP for 2016. So far the Central Bank of Turkey and the Undersecretariat of Treasury have been unaffected. If this were to change, investor nervousness could rapidly escalate into a wholesale sell-off of Turkish assets, given the important role that the two institutions have played in shoring up confidence in the financial markets and reassuring investors that the government’s uncompromising response will not affect the economy.
Despite the physical damage done to the parliament building during the coup attempt, the prime minister, Binali Yildirim, promised that the assembly would resume debate on a raft of business legislation that includes a bill to facilitate the employment of well-qualified foreigners. However, the response to the coup could further divert the attention of important politicians away from economic issues. With the exception of some media outlets, business groups have so far not been targeted in the government’s clampdown since the failed coup. But businesses that the government perceives to have been insufficiently supportive in the past, potentially including some of Turkey’s largest business groups and financial and industrial enterprises, might be at risk.