China’s slowing economy and its effects on Turkey

Umut Ergunsü

China’s slowing economy is a cause for major concern around the world. As one of the most prominent China experts on the economy, Michael Pettis argues that China will inevitably undergo a very difficult adjustment as it reverses the imbalances generated over the past three decades. All rapidly growing economies generate imbalances, and these always eventually reverse, but the roughly three dozen countries since World War II that have (according to Harvard economist Dani Rodrik) experienced over a decade or more of very rapid investment-driven growth have all had especially painful adjustments. These adjustments, which, typically in the form either of a debt crisis or of one or two decades of stagnation and rising debt, are likely to be reflected especially sharply in China given that the imbalances are far deeper in China’s case than they were during any of the preceding cases given that debt has risen far more rapidly.

The rebalancing process is not economically complicated, as the options are always quite limited, but instead is politically very complex. Reversing a growth model which has disproportionately benefitted certain elites who have amassed enormous wealth and political power over the past three decades – people who are referred to disparagingly in the Chinese press as the “vested interests” – necessarily creates significant political opposition from these vested interests. While the adjustment could come in the form of a financial crisis, Pettis argues that we are far more likely to see a less disruptive adjustment in which GDP growth slows substantially over the next decade or more while the growth in household income, after substantially lagging GDP growth for three decades, begins to lead growth. This has different implications for different sectors within the emerging markets, which will be affected by China’s adjustment in different ways. A further decline in the prices of metals and industrial commodities, for example, is an almost inevitable consequence of a rapid deceleration in investment growth and this might benefit Turkey for the metals it is importing, yet will almost most certainly hurt its iron and steel sector.

Pettis argues that the manufacturing sectors globally that had suffered most from the easy access of Chinese SOEs to cheap capital will probably see a recovery. But while most economists focus on the current account, it is important not to ignore the impact of China’s rebalancing on its capital account. A rebalancing China will inevitably produce a much smaller excess of domestic savings over domestic investment, and it is these excess savings which China exports to the United States, Europe and many emerging economies, including Turkey. Economies that rely on importing Chinese capital for their investment needs, such as Turkey, will suffer as China rebalances its economy. Unless the necessary preemptive adjustments are made to attract the escaping capital from China to be diverted into the housing and financial markets in Istanbul, Turkey will in general suffer from a reduction in investment by Chinese SOEs or as a consequence of Beijing’s policies.

 The harm will be lessened to the extent that Turkey can find ways to benefit from fleeing capital that will increasingly leave China to seek safe havens abroad, much of it invested in foreign real estate markets. 

If part of this capital is to be diverted to Istanbul real estate or to the Istanbul stock exchange, a perception among wealthy Chinese that the risk of investing in Turkey is quite low and legally protected will probably be far more effective than the desire for high returns. But the political steps required to create this perception are not obvious, and perceptions cannot change quickly, meaning Istanbul might already be too late in convincing Chinese elites to invest in Turkey, as they may have already established their safe havens elsewhere in the world, and Turkey’s image might not be terribly strong among these wealthy Chinese.

As Turkish economist Atilla Yeşilada points out, Turkey doesn’t export much to China, meaning a slowdown in China would not have much of an influence through the trade channel. On the other hand, the impact through the financial channel could be substantial. So far in 2016, emerging market assets have rallied strongly, one of the reasons for which was the observation that the Chinese economic growth stabilized. In 2017, much of the Emerging Market optimism hinges on the fact that despite its massive debt overhang, China will be able to sustain its growth momentum. 

Thanks to the emerging market rally, Turkey’s trials with terror, Russian sanctions and the abortive coup were partially overlooked, with the country attracting over $3.5 billion of financial capital (net of government borrowing). A Chinese slowdown could reverse the rally, exposing Turkey’s weakening economy and chaotic political fundamentals. In such a scenario, financial capital would take flight from Turkish markets, adding to the pressures on an already very fragile currency, leading to a potential balance of payments crisis or shock interest rate therapy by the Turkish Central Bank.

Noyan Rona, chief representative of Garanti Bank’s Shanghai office, thinks that although the slowing Chinese economy will adversely affect Turkey’s exports to China, if Turkey can turn this into an opportunity and manage to export to China consumer goods such as textiles and food products, there is a possibility that Turkey’s exports to China may increase.

Furthermore, the Chinese manufacturing sector is slowing down, and this is resulting in financial investment overseas. If Turkey manages to create an environment conducive to investment and is able to promote it in China, China might be willing to invest in Turkey. 

According to Rona, since commodity prices in the world are low, if Turkey can write a good development story, it could buy the intermediate goods, raw materials and the technology cheaper, leading to technology transfer.

Doruk Keser, chief representative at İşbank Shanghai Representative Office, has emphasized that the Chinese market is not growing due to consumption but raw materials. However, Turkey’s exports to China do not consist of consumer goods.

Looking at the future, Turkey and China could grow closer if Turkey claims more shares in the China Development Bank and AIIB. The China Development Bank is the world’s largest development oriented financial institution. According to China Daily, the bank has major assets that are twice the size of all development-oriented banks, including the World Bank.

Keser thinks that, since the RMB is included in the SDR basket, if Turkey uses the RMB to do trade with China or uses RMB as a reserve currency, the RMB’s fluctuations would influence the Turkish economy more.

 Furthermore, if Turkey takes more share from China’s “One Belt, One Road” initiative, it will get closer to China and will be more prone to fluctuations coming from China.