Strong lira vs. weak lira – reflecting on the ups and downs

Originally appeared on Bosphorus Consulting on 18 April 2014

Over the last year we have seen the lira drop by approximately 19% against the dollar. With the lira stabilising recently, albeit at a much lower level, Bosphorus Consulting considers the strong lira/weak lira trade-offs for Turkish businesses.

In 2013, Turkey’s foreign debt rose to 388,243 USD Million, its highest levels in the history of the republic, with its net external debt reaching 51% of GDP to place it third in the world in terms of the size of its current account deficit (Trading economics, “Turkey external debt”). The drop in the lira makes repaying these debts more costly and raises the premium on acquiring more money for new investments. The chairman of Anadolu Group, Tuncay Özilhan, lamented at a recent news conference that the depreciation of the lira had ruined the group’s budget plans for the coming year, meaning that any major investments would have to be put on hold and only urgent actions or already ongoing projects would be attempted (Reuters “Turkish lira’s dive wrecks balance sheets, deters foreign investment”, 27 January 2014).

This month, Turkey completed its scheduled repayments to the IMF, marking an important milestone in the country’s development. However, like a number of other emerging markets before it, the debt burden has been passed onto private companies. Goldman Sachs suggests in a recent report (Bloomberg, “Erdogan’s IMF Triumph Masks Surge in Private Debt: Turkey Credit”, 14 May 2014) that this accumulation of private sector debt may turn out to be “unsustainable” and that it represents a potential fault line, making the country vulnerable to external shocks. The report also notes that the drop in the lira combined with the huge amount of foreign debt represents a potentially toxic combination, which could pose a “threat to, … in the extreme, financial stability” (Bloomberg). Moreover, 57% of Turkey’s foreign debt accrued last year was short-term, raising the proportion of the country’s total debt that is short-term to 33%, which speeds up the possible negative consequences of this situation (Al Bawaba, “Breaking the record: Turkey’s foreign debt ‘highest in history’”, 15 April 2014). Added to this, a recent report by an economist from Turkey’s Central Bank, Bengu Alp, suggests that this varies by sector and that the 70% of the debt owed by the construction sector is foreign; since construction companies generally borrow so as to have working capital, these debts will probably be have been mostly taken on a short-term basis (read prominent Turkish economist Emre Deliveli’s concise summary of the report).

However, we would expect a weak lira to be good news for exporters, enabling them to sell their goods abroad at more competitive prices, but this appears to not necessarily be the case. The so-called ”J-curve,” the phenomenon experienced by Japan whereby its exports did not increase despite a depreciation of the currency against the dollar, represents a possibility for Turkey as well, with one reason for this being the subsequent relative increase in the price of energy (Hurriyet Daily News, “Japan’s (and Turkey’s) J-curse”, 3 March 2014). Turkey’s exporter association (TIM) stated it would prefer a stable currency to a weak lira. Moreover, the chairman of the Turkish Enterprise and Business Confederation TURKONFED, Suleyman Onatca, noted that small and medium-sized business were finding it harder to obtain loans for expansion because of the deprecation. Added to this, since many companies in Turkey export materials from Europe, paying for these in euros, the depreciation may not even help to make their products more competitive, as production costs would increase (Reuters). A survey by Turkey’s Central Bank, in fact, found that many companies rely on foreign inputs due to a lack of domestic versions of the same quality.

Nonetheless, part of Turkey’s attractiveness is surely down to its ability to produce goods at a cheaper rate, something which Ernst and Young’s 2013 Attractiveness Survey of Turkey notes on the one hand, describing the country’s (as yet largely untapped) potential, while on the other hand it also points to the country’s recurring image problem. Similarly, The Financial Times (“Turkey’s crisis rate fails to dispel dangers”, 21 January 2014) states there are definite opportunities for investors willing to tread these now slightly more uncertain waters. However, now they will be more discerning than before and companies will have to work harder to attract the investment they need.

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