The explosive rise of Turkey’s economy in the past decade is one of the most fascinating growth stories of all time. Since 2002, Turkey’s economy nearly quadrupled in size on the back of an epic boom in consumption and construction that led to the building of countless malls, skyscrapers, and ambitious infrastructure projects.
Like many emerging economies in the past decade, Turkey’s economy continued to grow virtually unabated through the Global Financial Crisis, while most Western economies stagnated.
Unfortunately, like most emerging market nations, Turkey’s economic boom has devolved into a dangerous bubble that is similar to the bubbles that caused the downfall of Western economies just six years ago. Though Turkey has received significant attention after its currency and financial markets fell sharply in the past year, there is still very little awareness of the country’s economic bubble itself and its frightening implications.
The emerging markets bubble began in 2009, shortly after China pursued an aggressive credit-driven infrastructure-based growth strategy to boost its economy during the global financial crisis. China’s economic growth immediately surged as construction activity increased dramatically, which drove a global raw materials boom that created a windfall for commodities exporting countries such as Australia and emerging markets. Emerging markets’ improving fortunes began to attract the attention of global investors who were seeking to diversify away from Western nations that were at the epicenter of the financial crisis. As the bubble progressed, even developing countries that were not significant commodities exporters (such as Turkey) began to benefit from the growing interest in this investment theme.
Rock-bottom interest rates in the U.S., Europe, and Japan, combined with the U.S. Federal Reserve’s multi-trillion dollar quantitative easing programs, encouraged a $4 trillion torrent of speculative “hot money” to flow into emerging market investments over the last several years. A global carry trade arose in which investors borrowed at low interest rates from the U.S. and Japan, invested the funds in high-yielding emerging market assets, and pocketed the interest rate differential or spread. Soaring demand for EM assets led to a bond bubble and ultra-low borrowing costs, which resulted in government-driven infrastructure booms, alarmingly fast credit growth, and property bubbles in numerous developing nations.
Like many other emerging nations, Turkey’s economic boom since the financial crisis has been heavily predicated upon a combination of foreign “hot money” inflows, ultra-low interest rates across the yield curve, rapid credit growth, and soaring asset prices. The charts of Turkey’s benchmark interest rate and three-month interbank rate show how they were cut to all-time lows in the years following the financial crisis:
Turkey’s idiosyncratic monetary policy of the past half-decade was responsible for these unusually low interest rates: Recep Tayyip Erdoğan, Turkey’s Prime Minister, believes that a zero real interest rate policy is the best practical implementation of sharia law’s ban on usury, or lending for interest, for modern Islamic societies.
“We aim to cut the real interest rate in the long run, so people will increase their incomes through working, not through interest,” he said in 2011. “Eventually we aim to equalize the interest rate and inflation rate.”
Turkey’s Economic “Miracle” Is Driven By A Credit Bubble
Ultra-low interest rates are, of course, notorious for creating temporary economic booms that are driven by credit and asset bubbles – a fact that likely wasn’t lost on Erdoğan, who vowed to make Turkey one of the world’s ten largest economies by 2023. Loans to Turkey’s private sector have more than quadrupled since 2008, even though the country’s real GDP only increased by approximately a third (and a good portion of that GDP increase was driven by debt):
Turkey’s M3 money supply – a broad measure of total money and credit in the economy – shows a similar ominous increase:
The emerging markets bond bubble enabled a corporate borrowing spree that caused Turkey’s external debt, or debt owed to foreign creditors, to surge to a record high of U.S.$372.6 billion or nearly 47 percent of the country’s GDP.
90 percent of Turkish corporate debt is denominated in foreign currencies, which dangerously exposes the country’s corporate borrowers to weakness in the Turkish lira currency, which is down by over 18 percent against the U.S. dollar in the past year:
Even more worrisome is the fact that U.S. $129.1 billion, or just over a third, of Turkey’s external debt is short-term debt that will come due in the next year, which is a sharp increase from the country’s short-term external debt of U.S. $100.6 billion at the end of 2012, and U.S. $52.52 billion external debt in 2008. Turkey’s short-term and long-term external debt have both increased at a faster rate than economic growth in the past half-decade. Having a large stock of short-term external debt makes economies more vulnerable to rising interest rates, as many emerging market nations have experienced in the past year after the U.S. Federal Reserve’s QE taper plans surfaced. Turkey’s short-term external debt burden exceeds 100 percent of its currency reserves, making it one of the highest risk emerging economies based on this metric.
One of the reasons for Turkey’s rapid accumulation of external debt in the past decade has been the need to finance its growing current account deficit, which the country’s economy has become increasingly reliant upon to continue growing:
Turkey’s current account deficit to GDP ratio has swelled to over 6 percent – a level that has led to currency crises in the past:
Turkey’s Consumption Boom Is Actually A Bubble
Accounting for 70 percent of Turkey’s GDP, consumer spending has been the country’s primary engine of economic growth in the past decade. Unfortunately, much of this consumer spending has been financed by debt, as with many other areas of Turkey’s economy. Personal loans grew at a scorching 61 percent average annual rate from 2005 to 2008 and barely slowed down after the financial crisis, while loans to households were increasing at a 28 percent annual rate in 2013. Credit is so free-flowing in Turkey that consumers are even able to receive approvals for personal loans via text message and ATM machines.
In addition to personal loans, credit card debt has played a significant role in enabling Turkey’s consumption boom, with credit card loans from the country’s leading banks having risen by 77 percent from 2010 to mid-2013. Turkey’s 74 million citizens now own 57 million credit cards and carry approximately $45 billion in outstanding credit card debt – nearly a third of which is considered to be nonperforming. Turkish consumers’ embrace of debt-driven consumption has caused household debt as a proportion of disposable income to rocket from 4.7 percent in 2002 to 50.4 percent in 2012.
As is common in low interest rate and credit bubble environments, Turkey’s consumption boom has been abetted by a savings rate that has fallen to its lowest level in at least three decades, which places Turkey dead last among fourteen other developing countries for this metric. An IMF study found that the average developing country has a savings rate of 33.5 percent, which is nearly triple Turkey’s 12.6 percent savings rate.
The combination of Turkey’s falling savings rate and credit binge has helped to propel the country’s consumer spending to an all-time high in the past decade:
Turkish consumers have focused much of their discretionary spending on goods such as automobiles, consumer electronics, and household appliances. Numerous foreign multinational corporations have flocked to Turkey to profit from the country’s spending boom.