Turkey’s Shaky Economy: a Local or Global Concern?

Turkey’s failed coup looks set to deliver a substantial blow to Turkey’s already wobbly economy. It could also renew concerns, post Brexit, about global emerging markets more broadly.

Late Friday, following initial reports that a coup was underway, the Turkish lira fell almost 5 percent, its steepest daily fall since 2008.  A broader sell-off seems likely on Monday, on the back of raised political uncertainty.  (My colleague, Steven Cook, puts the coup attempt in historical perspective here.) But economics also play a role here. With the growth outlook weakening recently, despite accommodative fiscal and monetary policy, and in the face of widening fiscal and external deficits, this weekend’s events are likely to contribute to a prolonged period of economic uncertainty. Notably:

• Following on the heels of the terrorist attack on Istanbul airport, this weekend’s turmoil look set to deliver a devastating blow to tourism revenue (already down 23 percent in May).
• The economy has been dependent on hot money inflows from abroad to finance a widening current account deficit. The government should be able to continue to fund itself, as its debt levels are moderate and local markets still supportive, but the possible, even likely, reversal of such flows could lead to a depreciating currency, higher inflation, and a spike in market interest rates. Watch Monday for signs of dollarization within Turkey for an early hint of how things are going.
• Growth of 4.5 percent in the first quarter appears artificial, driven by a 30 percent increase in the minimum wage and a recent easing in monetary and financial policies. According to the IMF, still-healthy trend growth of 3.5 percent is possible, but that would require substantially improved structural and fiscal policies.
• Inflation appears on the rise (7.6 percent in June, well above the central bank’s 5 percent target), and appointments by the government to the central bank board have weakened its perceived independence from the government and its anti-inflation fighting credentials. Today’s announcement by the government that it was coordinating closely with the central bank and news that the bank would provide unlimited liquidity to banks is smart crisis management, but could raise expectations that very easy monetary policy is in train.
• Turkey now could lose its investment grade rating, which will further weigh on investment and external debt prices. While it appears that portfolio investors are not overly exposed to Turkey relative to benchmarks, historically Turkish markets have been quite volatile following political shocks, and loss of the IG rating could lead to forced sales by investors that are mandated to invest in high quality assets.

The constructive story about the Turkish economy has long been anchored around greater integration in the global economy, and specifically strengthened trade and financial ties with Europe. Such hopes--including the anchor provided by the ambition of eventual EU membership--already were being called into question following the Brexit vote, and any effort by the Turkish government in the aftermath of the coup to extend government authority or adopt more nationalistic economic policies likely would further dampen interest in the west in strengthening economic ties.

More broadly, as I have noted previously, emerging markets have held up impressively in the aftermath of the Brexit vote last month. (Notably, Turkish stocks were up 15 percent this year prior to Friday’s events.) Firm expectations that U.S. interest rates will stay low, as well as evidence that stimulus measures in China were boosting growth, have keep these markets well anchored. Turkey’s importance in global markets on the surface appears small relative to these factors, so its reasonable to expect that Turkish markets eventually will find their footing and the risks will remain local. But any sense of a significant economic problem in Turkey, an important and liquid emerging market, could pull an important prop out of the benign emerging market story. That could be the economic legacy of this weekend’s events.