Financial meltdown in Turkey 2017 will not be a surprise: economist Mustafa Durmus

In a controversial move the Turkish government recently transferred the assets of major public companies, including the state-owned bank and telephone operator as well as a 49.12 stake in Turkish Airlines, to a new sovereign wealth fund.

The purpose of the fund totaling $8.8bn dollars (31.3bn Turkish Lira) is to finance big infrastructure projects according to the government. However critics have called it a “parallel budget” that will be used by the government, which has faced corruption accusations in the past, to advance its own interests and those of its business supporters.

Kom News spoke to financial expert and Associate Professor Mustafa Durmus about the Turkey’s new sovereign wealth fund.

Interview by Ozenc Eren*

Firstly, we would like to thank you for agreeing to our interview request. Let’s start with the most topical matter at hand.  Ziraat Bank, Turksat, BOTAS, PTT and the treasury’s shares in [Turkey’s] pipelines were transferred to Turkey’s sovereign wealth fund (SWF). Can you tell us about the reasons for and significance of this transfer? What exactly is the SWF?

Turkey’s sovereign wealth fund was formed in August 2016 with only 50 million [Turkish Lira] worth of capital. It was clear from the outset that such a fund could not be created with only 50 million [Turkish Lira]. When we examine the legislation creating the SWF, it allows for many things to be transferred to this fund – almost anything that belongs to Turkey, meaning anything that could be subject to privatisation – whether it be the unemployment insurance fund or the Personal Retirement System. The reason for this appears to me to be the desire to create a new political system, which the government has termed a presidential system. [The government] is planning to create the fiscal arm of this new regime in the form of a parallel treasury. The name of this parallel treasury, this parallel budget is the sovereign wealth fund.

So what is the difference between this SWF, which you’ve described as a parallel treasury, and the normal state budget?

The difference between the SWF and the normal state budget is that this budget does not need to be prepared by parliament. Similarly, it does not need to be approved by parliament nor does it need to be scrutinised by the state audit office. This fund has such a privileged status that it cannot be questioned or touched. This is why they are trying hard to expand it. There is even talk that Vakif Bank is next. It is also alleged that Halk Bank, which is owned by the treasury, will be transferred to this fund. The treasury already owns over 51% of the shares in these companies.

I see this fund as a very serious and radical change. The SWF, which is being thought of as the new system’s financial arm, is a fund where resources can be gathered and spent without any accountability. There isn’t a practice like this anywhere in the world. When we look at the existing sovereign wealth funds in the world – as in Norway, China and the Arab states – their systems do not resemble ours in any way. Norway and the Arab states’ funds are formed from the proceeds of revenue generated by oil sales, while China’s fund is formed from the proceeds of its trade surplus. It appears that what we have, on the other hand, will be run according to a logic that tries to govern without accountability by consolidating all existing [state-owned entities] into a single pot.

What benefits will this change have from an economic point of view?

This does not have any economic benefits whatsoever. Just as a fund that does not demand responsibility of those who use it will not contribute towards the economy, it can also create serious political issues. If this fund is already being thought of as the possible fiscal arm of the new system, I do not think that this parallel budget will remain limited to these transfers. It appears that with time, many financial resources, including even Unemployment Insurance, will be transferred here step by step. They are, in effect, testing the waters at the moment by making these transfers little by little.

What is the point of establishing this fund given the economic and political risks associated with it and the unlikelihood that it will provide any economic benefits?

It is a clear indication of both [the government’s] intentions as well as its needs. It is clear that a prospective new system will have substantial fiscal needs. Turkey has committed to a series of major infrastructure projects worth 350 billion dollars. These projects are mostly funded by foreign capital and are due to be completed by 2023. The guarantee on these projects to be met by the treasury and Turkey’s conditional obligations amounts to over 100 billion dollars. When we do the sums for all of this we are left with a very large balance sheet. It isn’t easy to tell how this balance sheet will be managed, how Turkey will face its commitments and how its impact will be lightened. The truth is, one shouldn’t really expect a particularly positive outcome from all of this.

Pessimism regarding the economy is widespread. International credit rating agency Fitch downgraded Turkey’s rating no longer considering the country as investable while Standard Poor’s downgraded Turkey from “stable” to “negative.” The World Bank economic growth forecast fell from 3 to 2.7% and the Turkish Lira has lost considerable value against foreign currencies. What effects do you think these developments will have in the short and long run?

Three large credit rating agencies including Fitch rated investment at “junk level.” The revised forecast of the World Bank is a sign that 2017 is expected to be a year of decline. Turkey also has a regime change referendum ahead. This phase has polarised society and had a negative impact on the economy from top to bottom. Moreover, state of emergency has been extended twice. Put together, all these things will definitely have a negative impact on investors, first and foremost foreign investors since Turkey is an economy dependant on foreign investment.

We have witnessed an increase in foreign capital outflow and an inflow decline for a while now, so the impacts are already visible. As long as political instability continues and polarisation augments, investments will decrease even more. Accordingly, we could guess that the economy will shrink significantly.

It can be summed  up as follows: the negative impact of this climate on investors’ decisions will have an even greater negative impact on growth and lead to revisions. Secondly, this situation will push the exchange rate upwards.

Even though we are witnessing all this happen, the exchange rate began to drop a week ago. How can we explain this?

There are two reasons for this. First, the Central Bank has actually raised the so-called late liquidity window interest rates, first from 8.5% to 10%, and then eventually to 11%. The results of the raised interest rates are that investors exchange a certain amount of their currency into Turkish Lira. But we have to ask ourselves if it will be possible to keep the interest rates at a high level or if it’s possible to raise them even more. The answer is simple, the Central Bank won’t be able to raise the interest rates any higher. If you ask me, it won’t be possible to maintain the current late liquidity interest rates. That’s why I think the currency exchange rate will soar again.

The second reason for the drop is the “net errors and omissions” part in the balance sheets of the Central Bank, i.e. unforeseen capital inflow. If you ask me, something is stirring here. I’m talking about capital inflow from the Gulf or of other foreign origins. This sort of immediate capital inflow has pushed the exchange rates down to a certain extent.

I think the change in trend can be explained with these two reasons, however neither are lasting – especially not the interest rate situation. We can expect the exchange rate to go up as we approach the referendum. A rise in inflation stemming from the exchange rate will push up costs. As a result, Turkey’s economy while shrinking will also face great inflation. It shouldn’t come as a surprise if we witness a recession or even depression, unemployment and inflation at serious levels in Turkey’s economy.

Economic anthropologist David Graeber, whom we interviewed last week, made similar predictions. Actually, he said Turkey would enter a serious economis crisis in 2017. Do you think this is a pessimistic outlook or is Turkey really on the way towards an economc crisis?

Unfortunately, this is not a pessimistic approach. We are saying it, economists are saying it, financial institutions are saying it – even the World Bank and the IMF are saying it in their reports. All the signs of a crisis are there, it’s enough to look at the exchange rate, the interest rate, the debt increase – in particular in the private sector – and the increased budget deficit. There are other signs too such as unemployment and shrinking growth.

So I can’t deem David Graeber’s outlook as pessimistic. Quite the opposite, I think it’s a very realistic outlook. Perhaps it’s not even unrealistic to discuss the dimensions of the crisis and what it will look like.

What do you mean when you mention the dimensions of the crisis?

I see the possibility of a two-dimensional crisis. One of these is already felt in the shrinking real economy and will be even more visible as bankruptcies and unemployment mount. The second is a financial crisis tied to the banking sector, a banking crisis in other words. There a signs also of this crisis. In their last report, American multinational financial services corporation Morgan Stanley revealed that some banks have big problems. If you look at the balance sheets, there is a serious increase in non-performing loans and uncollectible bad debts. The banks and the financial sector are harmed by the bad credit increase and currency leaps. A financial, banking or debt related crisis can deepen really fast. That’s why I consider a two-dimensional crisis possible.

In conclusion, there are already signs in the banking sector of a scenario where – as the relevant literature says – the banks go bankrupt followed by a crisis in the real economy. It should therefore not come as a surprise if the financial crisis leads to a major general crisis.

Associate Professor Mustafa Durmus completed his PhD at the Department of Public Finance at Gazi University. He was a lecturer at York University between 1989-1991 where he also completed his post-doctoral programme. In 1992, he worked as a lecturer and doctoral supervisor at the American University of London. After having worked as a lecturer at the Department of Public Finance, he returned to Gazi University where he currently works in the Economic and Administrative Sciences Faculty.