Turkey faces the “real risk” of a sudden stop in short-term capital inflows that the nation depends on to finance its current-account deficit, according to Nobel laureate Joseph Stiglitz.
Interest rates at below the inflation rate have encouraged investments in real estate at the expense of manufacturing and other productive export sectors, Stiglitz, 71, said. That has a distortive effect on the economy, raising concerns about longer term growth potential when changes in global liquidity make capital for riskier markets more scarce, he said.
“Money goes in and then all of a sudden sentiment changes and they say, ‘Sorry, we want our money back,’” Stiglitz, a Columbia University professor who won the 2001 Nobel Prize in economics, said in an interview in Istanbul on Aug. 17. “Then the exchange rate collapses, inflation soars, and you have a nice crisis.”
Pacific Investment Management Co., the world’s biggest bond manager, said last week Turkey faces an investor exodus should rating companies downgrade the nation’s debt. Turkey relies on short-term capital flows to plug its current-account deficit, which the government singles out as the economy’s biggest vulnerability. The shortfall, which reached a record of about 10 percent of gross domestic product in 2011, was relatively easy to finance as the U.S. lowered borrowing costs to record following the 2008 financial crisis, sending investors in search of higher yields abroad.
Foreign investors poured almost $80 billion into Turkish stocks and bonds since 2005, attracted by the prospect of borrowing at record-low rates in the U.S., Europe or Japan and reinvesting at Turkish rates. The yield on Turkey’s two-year notes was 9.21 percent at 10:49 a.m. in Istanbul, higher than all of 21 comparable major emerging markets except Brazil.
The capital flows also allowed Turkey to cut its interest rates in kind, with the central bank slashing the main rate to a record 4.5 percent until a rapid decline in the lira forced it to make an emergency increase in January. The rate is now at 8.25 percent, compared with inflation above 9 percent for the past four months.
While Stiglitz says negative real rates encouraged short-term investments, he also said Turkish central bank Governor Erdem Basci’s management of inflows through a variety of tools including a so-called interest rates corridor, reserve requirements and regulatory tools was an example for other central banks worldwide.
“Turkey and a couple of others have made central banks aware that they should use more instruments than just interest rates,” he said. Turkey could now consider using capital controls to help restructure the economy away from real estate to manufacturing, he said.
“Even the IMF now endorses the idea of capital controls,” he said. “You don’t want this hot money, and you don’t have to be as passive as people think.”
Even though major economies in Europe are stalling, any stimulus in the EU probably wouldn’t prolong Turkey’s run as a prime destination for quick capital inflows, Stiglitz said.
Recession in Europe means the continuation of “easy monetary conditions, but it probably means that banks will be very reluctant about funding Turkey’s deficit directly or indirectly,” Stiglitz said. “You don’t want to be sending money to Turkey and getting back pieces of paper.”
Deputy Prime Minister Ali Babacan told NTV television last month that the share of manufacturing in the economy needs to grow to help narrow the deficit. The amount of investments made by private companies is not at “desired levels,” which makes high-speed growth unsustainable, he said.
The $820 billion economy will probably grow at an average 2.7 percent this year and next, compared with 9.2 percent in 2010, when the pace of expansion rivaled China’s, according to International Monetary Fund estimates. The share of industry in Turkey’s GDP dropped to 23 percent last year from 33 percent in 1998, according to Turkish official statistics.
Turkey runs the danger of compounding slowing capital inflows with growing reluctance by international companies to make long-term investments amid concerns of erosion in rule of law, Stiglitz said. Turkey’s judiciary is being reshaped as Prime Minister Recep Tayyip Erdogan says he’ll eliminate members of an Islamic sect from the bureaucracy, accusing them of being behind a corruption probe last year that he says was a coup attempt.
Islamic lender Asya Katilim Bankasi AS has been caught in the crossfire between Erdogan’s government and U.S.-based Islamic preacher Fethullah Gulen, whose followers founded the bank. In the past two weeks, Bank Asya has seen its agreements with Turkey’s tax administration and customs offices canceled, its shares have been frozen on the stock exchange and the capital markets regulator refused to consider its request to raise money by selling debt.
Erdogan attended the bank’s opening ceremony in 1996 along with Gulen, who was then a political ally. The two have since split, with Erdogan saying Gulen is managing a so-called “parallel state” within Turkey’s bureaucracy that’s trying to undermine him.
“Corporations are long-term investors, and they don’t want the precariousness of the government one moment liking you and the next moment vindictively having the power to screw you,” Stiglitz said. “Good businesses say: ‘We don’t want favors, because you can take those away.’”