Fallout from Turkey’s currency depreciation: Credit restructuring

Let’s quickly remember the most important items of business news in Turkey from the past 10 days: Firstly, the Central Bank announced net profits of 18.3 billion Turkish Liras ($4.5 billion) for 2017. This means that the Bank will probably top the corporate tax champion list. Secondly, 2017 GDP growth came in at 7.4 percent. Finally, it was reported that the Doğuş Group is seeking to restructure its 7.8 billion-lira short-term debt.

Taken together, these news items would make a good question in an exam for students of the Turkish economy.

There have been three main reports related to debt repayment in the country recently. Oger Telekom, the majority shareholder in Türk Telekom, failed to pay its $4.4 billion debts. Yıldız Holding has demanded a debt restructuring. And there is the case of Doğuş Holding. What all these cases have in common is the fact that banks’ cash flows will be affected.

The case of Yıldız Holding shows that businesses that buy assets with short-term financing are now having troubles. The case of Doğuş shows that the depreciation of the lira is inflicting significant damage. Doğuş Group’s short FX position is $4.7 billion, while its short and long-term financial debt is $6.2 billion (23.5 billion liras). Therefore its additional burden from a 1 percent increase in interest rates is 60 million liras, while the additional burden from a 1 percent depreciation in the currency is 116 million liras. Which one is more damaging:

An increase in the interest rates or a depreciation of the currency? The answer to this question is clear: The impact of the exchange rate is twice as high.

The short FX position of the non-financial sector is $221 billion. Turkish companies increased their debts in an amount corresponding to 30 percent of the country’s overall national income between 2007 and 2011.

Foreign investors, particularly credit rating agencies, stress precisely this point: In the wake of the global economic crisis, the second highest increase in private companies’ debt was recorded in Turkey, following China. The roll-over of this debt will become more difficult given the depreciation of the lira, relatively slow revenue generation, and rising costs.

So why have companies with important brands under their roofs started to experience debt roll-over problems in a country with over 7 percent economic growth?

It is not possible to understand this situation by focusing on a single year. Damages that have accumulated since 2013 are creating major problems for companies.

The cumulative nominal national income has grown by 97 percent since the end of 2012 (the cumulative real increase is 34.1 percent), but the lira has depreciated by 113 percent in the same period. This means that companies with lira revenues but debt in foreign currencies cannot repay their foreign exchange-denominated debts.

This difference is getting wider by the day. Exchange rates keep rising and they are not likely to reverse course while the real sector suffers from currency depreciation. Damage from the decline in the value of lira will be difficult to repair and banks will eventually be affected.

Given this outlook, it is significant that the Central Bank has posted record profits. Past experiences showed that when the economy is in good shape, companies and banks take the lead in posting record profits and the revenues of the Central Bank decline. The national lender even posts losses at such times.

When a country experiences exchange rate shocks, central banks tend to post high profit. Some 70 percent of the Turkish Central Bank’s profit between 2014 and 2016 was due to the rise in exchange rates.

The Bank was “winning” but companies were losing. The profit that the Central Bank posted between 2011 and 2015 was 47.2 billion liras ($11.6 billion), but its two-year profit between 2016 and 2017 was 30 billion liras.

Debt restructuring by large companies raises questions about that financing difficulties that small and medium-sized enterprises (SMEs) face. What boosted economic growth in 2017 and saved SMEs were loans extended under the Credit Guarantee Fund scheme.

This year, some of those due loans will be renewed but the additional financing facility looks unlikely. Banks have limited resources to extend additional loans, while no economic policy that will curb the rises in exchange rates and interest rates is currently on the horizon.

On the contrary, the outlook suggests that companies’ financials will suffer from higher costs.

The warning that “the roof needs to be repaired when the weather is good” may have been right, even though it was a bit late.