TURKEY: IN EYE OF EMERGING MARKET STORM AS EVERYTHING GOES WRONG AT ONCE

Turkey in eye of emerging market storm as everything goes wrong at once

Hedge funds close in on countries with the worst current account profiles and Turkey is looking naked with a deficit of 7.6pc of GDP

Pictures of the day: 10 February 2014

Turkish riot police takes cover behind their shields as firework shot by protesters explodes in front of them during clashes within an anti government protest Photo: Jivan Guner

By Ambrose Evans-Pritchard, in Ankara

6:00AM GMT 17 Feb 2014

Turkey's finance minister knows his country is in the cross-hairs as the US and China tighten the liquidity spigot, viewed by many as the most vulnerable of the big emerging market states, and potentially the detonator of a broader global crisis.

Mehmet Şimşek is a poacher turned game-keeper. He used to work for Merrill Lynch and is a well-known face in London. Indeed, he is a British citizen.

"We are aware it's going to be tough," he said, admitting that the government woke up to a "changed world" last year as US Federal Reserve turned hawkish.

"We are not going to fight the markets because we know we can't win. We'll let the adjustment take place, as it already has with the currency," he said.

Everything has gone wrong at once. Hedge funds are closing in on those countries with the worst current account profiles, and Turkey is looking naked with a deficit of 7.6pc of GDP. Foreign reserves have fallen to two months import cover.
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The International Monetary Fund issued a blistering report in December, warning that Turkey is on an "unsustainable" path, with gross external financing requirements above 25pc of GDP per year. It said monetary and fiscal policy were both too loose.

There has been a chronic erosion of Turkey's net foreign asset position since 2008 to minus 53pc of GDP. Investment in factories and plant (FDI) has dried up, replaced by hot money. The IMF said Turkey risks a "sudden stop" in capital flows that could trigger recession.

The country has been skating on thin ice ever since mass protests last June, put down by police with live ammunition. This took a turn for the worse with the eruption of a bitter power-struggle within the Islamist movement of premier Tayyip Recep Erdogan, the "events of December 17".

It was triggered by corruption probes against party elites, including three children of cabinet ministers. Mr Erdogan responded with a purge of the judiciary and police, claiming that a "parallel state" was orchestrating a judicial coup.

"This has gone beyond tinkering and become really serious: Erdogan can't just roll up democratic institutions," said one diplomat. "Fund managers who thought Turkey was stable tell us they now have to worry about political risk, or even whether contracts will be enforced."

Standard & Poor's cited rising political tensions as a key risk when it placed the country on negative watch a week ago, saying Turkey "appears to have suffered an unanticipated erosion of institutional checks and balances."

Mr Şimşek said critics have blown the drama out of proportion. "Political stability is not a stake. Fall-out from corruption investigations is likely to be very limited. We will not waste this crisis: we will respond by enhancing standards of accountability," he said.

Turkey has little safety margin. A report by UBS said Turkey is almost as vulnerable as Thailand before it set off the Asian crisis in 1997, and worse in key respects. Its savings rate is 12.6pc compared to 33pc in Thailand then.

Short-term foreign debt has jumped five-fold to $90bn since 2007, according to S&P. This has to be rolled over continuously. Much of the dollar debt is "unhedged" and has fuelled a construction boom. Borrowers face a triple squeeze from rising rates, a 22pc fall in the lira over the last year, and a slump in growth. The IMF says the era of Chinese-style growth rates of 9pc will never return.

"We have a source of vulnerability in the current account deficit but there is no quick fix. We are doing everything we can to contain it," said Mr Şimşek, insisting that last year's deficit was driven up by Europe's recession and a one-off surge in gold imports worth 1.5pc of GDP.

"Turkey is an open economy. We'll maintain market-friendly policies. There'll be no restrictions on capital movements," he said, denying rumours that Turkey would impose curbs like Egypt, Ukraine, and Ghana. Households are "largely immune" from any crisis. There are no foreign currency mortgages -- unlike Eastern Europe -- and few floating rate loans.

Mr Şimşek said Turkey has seen $5bn of capital outflows over the last six weeks, including swaps contracts. The crucial question is whether money will return following the "shock and awe" move by the central bank in late January to double interest rates to 10pc. Turkey needs net inflows of $5bn a month just to keep an even keel.

There were inflows of $2.9bn into equities and bonds in the week to February 7th, according to EPFR Global. But this data tracks foreign investors, not local financiers who tend to sniff out political trouble earlier.

"Some funds are fishing for bargains at the bottom, but who knows where the bottom is," said Tayfum Beyazit, head of the finance committee of the business lobby TUSIAD.

Interest rates are still near zero in real terms, underscoring how loose the central bank had become last year in a doomed effort to keep the party going. It must now act with its back to the wall.

The optimistic view is that the crisis has at last forced Turkey to do the right thing: raise rates, and weaken the currency. "If you had to devise an IMF-style package this is what the policy would have been, so they got there in the end," said one financier.

Mr Şimşek said there is no comparison with the emerging market crisis of the 1990s. "Countries were literally starved of capital. The EM universe is in much better shape today," he said.

In any case, they took the hit last May when the Fed first began to talk of bond tapering, he said. The end of easy global money is already in the price.

That at least is the fond hope.