LONDON, June 17 (Reuters) - Tayyip Erdogan seems to like
the concept of "choking" things. At the weekend, Turkey's prime
minister sent riot police into an Istanbul park with tear gas and water cannons
to clear out the protesters. A week earlier, he had threatened to
"choke" an alleged "high-interest-rate lobby" of
speculators who wanted to push interest rates up and suffocate the economy.
***
Reuters/Reuters - Anti-government protesters try to
protect themselves from a water cannon as riot police disperse them during a
protest in Ankara June 5, 2013. REUTERS/Umit Bektas
By Hugo Dixon
LONDON, June 17 (Reuters) - Tayyip Erdogan seems to like
the concept of "choking" things. At the weekend, Turkey's prime
minister sent riot police into an Istanbul park with tear gas and water cannons
to clear out the protesters. A week earlier, he had threatened to
"choke" an alleged "high-interest-rate lobby" of
speculators who wanted to push interest rates up and suffocate the economy.
Erdogan's harsh actions against protesters and harsh
words against investors could backfire economically. The country depends on
foreign investors to fund its big current account deficit. If they turn tail in
response to the mounting unrest, interest rates will indeed have to rise.
The protests which began two weeks ago over Tayyip
Erdogan's alleged authoritarianism, triggered by the prime minister's
insistence on bulldozing one of Istanbul's few public parks, initially alarmed
investors. The stock market plunged, the lira fell and government bond yields
spiked. Then, after the central bank intervened in the foreign exchange market
and Erdogan offered concessions last week, investors calmed down.
But the weekend's use of riot police has stoked a
conflict that seemed like it might be on the point of resolution.
The problem is not so much that speculators have an
incentive to jack up interest rates. This would be perverse. Foreign investors
own $140 billion of domestic bonds and equities, according to Standard Bank.
They will lose money if interest rates rise.
The risk rather is that investors will pull out their
money if they lose confidence. The U.S. Federal Reserve's indication that it
may slow down its massive bond-purchasing program has exacerbated that risk, as
some of the money it has been pumping into U.S. bonds has seeped into emerging
markets such as Turkey.
What's more, the Turkish miracle isn't quite as good as
it seems. The economy grew only 2.6 percent last year, down from 8.5 percent
the previous year - after the central bank had to hike interest rates because
the economy was overheating and inflation reached 8.9 percent last year.
Turkey's biggest economic weakness is its current account
deficit - a sign that consumption has been growing faster than is sustainable.
The deficit did fall to 5.9 percent of GDP last year, after a 9.7 percent gap
the previous year, as the economy slowed. But it is rising again this year. The
April trade deficit was $10.3 billion, up from $6.6 billion last year.
Indeed, the selloff in Turkey's financial markets began a
week or so before the police crackdown on protesters in Istanbul's Taksim
Square on May 31. For example, two-year bond yields rose from 4.8 percent on
May 17 to 6 percent at the end of the month; and the stock market fell 8
percent between May 22 and the end of the month.
Until now, international investors have been happy to
fund the deficit. Not only were they attracted by the strong economic growth.
They also liked Erdogan's pro-market approach, the political stability they
thought he had brought and the prospect that Turkey's march towards a market
democracy would be anchored by negotiations to join the European Union, says
Timothy Ash, Standard Bank's head of emerging markets research.
The "interest-rate lobby" also liked the fact
that the government's debt is only 35 percent of GDP and that banks have strong
balance sheets, partly because they were seared by Turkey's financial crisis at
the start of the millennium. Meanwhile, both Moody's and Fitch recently
upgraded the country to investment grade.
The problem is that the unrest is casting doubt on some
of these positive factors. For a start, Turkey no longer looks so stable
politically. Then there's the fact that Erdogan's attack on speculators is
sowing doubts about the depth of his commitment to markets. Furthermore, the
crackdown on protesters may undermine Turkey's chances of joining the EU after
Germany last week suggested delaying the next round of negotiations. What's
more, the unrest could harm growth if tourists are deterred from visiting and
domestic consumers become more cautious.
A particular weakness is that the current account deficit
has been largely funded with hot money. The share accounted for by foreign
direct investment - long-term money that can't easily run away - has been
falling, according to Morgan Stanley. Meanwhile, the share made up by debt has
been on the rise.
One measure of Turkey's vulnerability to a loss of
confidence is that it has an "external financing requirement" of $205
billion - roughly a quarter of GDP - over the next year, according to Standard
Bank. This financing requirement is the sum of its current account deficit and
the maturing debt it needs to repay or roll over. A more extreme measure of
vulnerability would add the $140 billion of foreign held bonds and shares. If
this tries to flee, the lira could plunge.
Against this, the central bank has $130 billion of
reserves, which it dipped into last week when it helped to stabilize the
foreign exchange market. This war chest, though, is low compared to Turkey's
external financing needs. What's more, the net reserves - after excluding
foreign exchange deposited by the banking system - are only $46 billion,
according to Standard Bank.
So the central bank couldn't hold the line if the
"interest-rate lobby" really did run for the exits. In that case,
Turkey would have to raise interest rates, which would damage growth. And then
the economic miracle, which Erdogan has presided over and which is one of the
main sources of his popularity, might look like a conjuring trick. Instead of
choking protesters, Turkey's prime minister should try to make a genuine peace
with them.
CONTEXT NEWS
- Turkish Prime Minister Tayyip Erdogan rallied hundreds
of thousands of supporters at an Istanbul parade ground on June 16 as riot
police fired teargas in the city center to disperse anti-government protesters.
- Erdogan told supporters that two weeks of protests had
been manipulated by "terrorists" and dismissed suggestions that he
was behaving like a dictator.
- Last week Erdogan threatened to "choke"
financial market speculators who he said were growing rich off "the sweat
of the people". Erdogan blamed a "high-interest-rate lobby" for
causing volatility in financial markets and vowed to stop them.
(Hugo Dixon is Editor-at-Large, Reuters News. The opinions
expressed are his own.)
(Editing by Sarah Bailey)
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