This place is different
Today Turkey’s crisis is not only a health crisis followed by the coronavirus outbreak and an economic crisis triggered by it. Rather, it is a health crisis and an economic crisis triggered by it, on the top of an already ongoing economic crisis due to foreign currency debts of non-financial corporations. Cookie cutter applications of what may work elsewhere will not work in Turkey.
Today Turkey’s crisis is not only a health crisis followed by the coronavirus outbreak and an economic crisis triggered by it. Rather, it is a health crisis and an economic crisis triggered by it, on the top of an already ongoing economic crisis due to foreign currency debts of non-financial corporations. To see Turkey was already in a crisis before the pandemic hit, note that while the unemployment rate at the beginning of 2020 was about 3.5% in the U.S. (and in Germany, and similarly low in most advanced economies) it was about 13.5% in Turkey. “Normal” unemployment is high here but not nearly that high.
Cookie cutter applications of what may work elsewhere will not work in Turkey. Some policies are appropriate for dealing with the repercussions of virus-hit supply chains, mandatory closure orders, and workers in quarantine on the supply side; and a general collapse of incomes and the desire, as well as the ability, to spend on the demand side. Those are certainly problems in Turkey as well. But there is more, and that more interacts with any proposed policies.
A top policy option offered to advanced economies is money financed spending, in particular transfers to households and small firms. This is a sensible policy, putting aside the political economy of whether the job itself should be done by central banks directly or by fiscal authorities by increasing debt, to be monetized by central banks later. The latter option is likely preferable for making it clear that transfers are fiscal policy to be set by elected decisionmakers. But, either way, a very likely outcome of outright monetization is inflation, which in small doses will be welcome by advanced economies that are currently undershooting their inflation targets. If the inflation rises too much, that is the enemy we all know. It may take a recession in a few years down the road, but most central banks can tackle that.
The Turkish case is more complex. The two important confounding factors in Turkey are foreign currency debt and the loss of policy making capacity. In the summer of 2018, Turkish lira depreciated deeply, laying bare the core current vulnerability of the Turkish economy: foreign currency debt of non-financial corporations. (Which itself was the result of haphazard policy in the aftermath of the global financial crisis.) This led to a wave of insolvencies, postponed by regulatory “forbearance” which made the banks restructure the loans so as to delay the payments. That only helps when the problem is liquidity. These firms were insolvent then, are insolvent now. Which is partly why, although the contraction paused towards the end of 2019, employment did not increase. Insolvent firms look to shed assets and downsize, not to add employees.
The important point here is the Turkish economy’s need for foreign currency. That, we do not print. Monetization works in countries where debt, public and private, is in domestic currency so that it can be monetized by the central bank. In countries with foreign currency debt, what is needed is a real resource that cannot be printed. In fact, unchecked monetization will make things worse by depreciating the domestic currency and hurting the foreign currency borrowers even more.
As a stopgap measure, creating some money to help households and small firms at a time of unprecedented crisis may be part of a palliative care package. This may in fact be necessary in a country with low state capacity, unable to collect taxes, and atrocious procyclical fiscal policy that has overspent in better times to pump up demand rather than undertaking policies to increase productive capacity. However, if the only policy is leaning on the Central Bank, the increased lira liquidity will find its way to foreign currency demand, depreciating the lira. This is already ongoing. Monetization cannot be a main funding mechanism in any sizable and long-term program in Turkey.
There are four ways of bringing in foreign currency, not counting capital controls and taking over foreign currency deposits, which would be disastrous in a country like Turkey that has continuing foreign financing needs. Debt can be dealt with using brute force but ongoing deficits will still have to be financed—Turkey still needs capital inflows to grow--and that will not be possible if domestic savers and holders of foreign currency are severely penalized. Hence, the four ways.
First, not an option now, is to increase exports. That is not going to happen at a rate that will cover the close to 175 billion dollars that needs rolled over this year. (But the decline in oil prices and imports overall are helping by reducing the foreign currency outflows.) Second is borrowing from international markets. This is where one notes that the Turkish Treasury pays about 10% per year to borrow at a five year maturity in dollars, whereas the U.S. Treasury pays less than 1% to borrow at ten-years, and several countries such as Germany (in euros), borrow with negative interest rates. The cost of market finance is prohibitive due to the political and economic risk in Turkey, which relates to the lack of administrative capacity (more on that below).
The third way is to find a swap line to advanced economy central banks, in particular to the Fed, so that liras can be exchanged with dollars and lira liquidity can be used to generate dollar liquidity in Turkey. The politics of this aside, these are short-term swap lines, not long-term debt. The dollars will have to be swapped back for liras soon, hence while certainly helpful in providing liquidity during a market dislocation, this is not the way one buys time for structural reforms in an environment with widespread insolvencies. That leaves the fourth option, borrowing from international organizations, commonly known as the IMF programs. It seems this will be the case, sooner or later; and in a willful and organized way or during a time of acute crisis and accepting whatever the IMF comes up with.
Two points are worth noting here. First, this is not really a preference for dealing with the IMF among many options. It is more of a necessity. Other options are either infeasible, such as a massive export boom without an accompanying import boom; or just kick the can further down the road again without addressing the main problem, such as a swap line with the Fed. Second, IMF programs work when the recipient country has the competence to design a proper program itself and ask the IMF for funding, oversight, and auditing. In that case, local expertise that knows what will work is combined with wholesale funding and the public knowledge that the promises of the program will be audited by the largest lender. This helps bring other lenders in as well.
That brings us to the particularly troublesome current Turkish problem of lack of such expertise and understanding among policymakers and the bureaucracy. This loss of policymaking capacity was plainly visible in the recent announcement of a curfew two hours before it was to be instituted, making hordes of people rush to markets. There was apparently either no one to point out that this would be the case, or no one to heed sensible advice, or both.
Things are not much different in the economic policy sphere. Thus, designing and implementing a workable program will also require a rethinking of the way we do policy and bringing in competent public servants and policymakers again. Those people are not in short supply in Turkey, they just are not involved in policymaking now. Doing decent policy requires decent policymakers, working in a decent policymaking regime. That is not easy now in Turkey, but is very possible.
This should have been clear by now: The Central Bank funding of the government spending is a reasonable and even desirable policy option in some countries. Turkey is not one of those. Leaning on the Central Bank for funding here will aggravate the core underlying problem, that of excessive foreign currency indebtedness. Lira monetization is fool’s gold. Any short-term policy, including short-term funding from the Central Bank, has to be combined with a program to bring in longer-term foreign currency and a reform program that will make that foreign currency borrowing sustainable as well as laying the foundations of a better, more inclusive growth path. This will be painful but it has to be done, sooner rather than later. And the sooner we bring back the policymaking capacity to do so, clearly the better.