CEIC News@lert: Thematic Analysis of Capital Flows to Emerging Markets: Effects of US Tapering on the Turkish Economy

December 19, 2013 HIGHLIGHTS Since May 2013, when the United States’ Federal Reserve announced that it would be gradually scaling back its quantitative easing (QE) programme, emerging markets have seen large capital outflows and rising interest rates pushing up borrowing costs. With global investors becoming more selective after the Federal Reserve’s exit programme, risk premiums on foreign debt securities, domestic interest rates and equity indices in these emerging economies are facing significant upward pressures. Turkey, with its high current account deficit (5.7% of GDP as of the third quarter of 2013) and high external borrowings relative to foreign exchange reserves, has become one of the worst–affected economies among the fragile emerging countries. Capital outflows from Turkey since May 2013 can be traced by the deteriorating International Investment Position (IIP) of the country. Non-residents’ direct investment in Turkey (including other capital and equity capital) as of the end of September 2013 stood at USD 160.4 billion, representing an 11.4% decrease compared to the end of the previous year and a 15.4% fall compared to April 2013. Portfolio investments increased by 14.9% in September year-on-year (yoy) and managed to stabilise after the fall experienced since April 2013. In September 2013, portfolio investment amounted to USD 173.4 billion while other investment, comprised mainly of loans and deposits, totalled USD 292.6 billion. Not only have portfolio investment outflows affected net IIP, but this movement has also caused a serious exchange rate depreciation of the Turkish Lira and lowered the country’s foreign exchange reserves despite the central bank’s counteractive measures. The central bank initially tightened local currency liquidity and reintroduced daily foreign exchange selling auctions in early June. The bank has also raised its overnight lending rate by 125 basis points in two steps since late June to 7.75% but has avoided an increase in its main policy interest rate (the repo rate), which is unchanged at 4.5%. However, these policy interventions have not been able to substantially stem the Lira’s fall and the currency depreciated by almost 11% from May to November 2013, reaching TRY 2.02/USD. The increased focus of the central bank on exchange rate stability may contain the risk of huge currency depreciation for the time being, but this comes at a cost of depleting foreign exchange reserves. The high level of external debt in both the banking and the corporate sectors, and the heavy reliance on short-term capital inflows from abroad, make Turkey susceptible to external shocks. Gross external debt amounted to USD 367.4 billion as of the second quarter of 2013, an increase of 14% compared to the same quarter of the previous year. The short-term external debt stock increased to USD 125.7 billion in the second quarter of 2013 and expanded by 30% on an annual basis, recording the highest increase since the heightened global alert on QE tapering. The long-term external debt amounted to USD 241.7 billion, growing by 7% yoy in the second quarter of 2013. Private sector external debt accounted for almost 85% of total short-term external debt, reaching USD 109.3 billion by the second quarter of 2013, a 32% yoy increase. Short-term private external debt comprises financial institutions’ debt which takes up 65% of the total, while the rest comes from non-financial institutions’ debt. The upward trend in private sector short-term external debt reveals a worrying scenario for Turkey when combined with the exchange rate depreciation, increasing the debt burden for both the public and private sector. The foreign reserves to short-term external debt ratio serves as a red flag to potential liquidity issues in the debt financing process. A country with a low ratio is more open to speculative or external shocks due to an erosion of its reserves against rising short-term obligations. In the second quarter of 2013 this ratio for Turkey fell to its lowest level for the last five years. The country’s official reserves are now insufficient to cover its short-term external debt obligations -- this exposes the economy to speculative attacks. At first glance, the rapid capital outflow from the financial market was the main cause of the sudden dip in the national equity market benchmark index (BIST 100), which recorded a loss of 12% in value from May to November 2013, accompanied by surging benchmark government bond yields from 6% to 8.7% over the same period. However, foreign holdings of equities and government debt stock measured at market value have rallied since August 2013 amid the longer horizon on US tapering schedule. In November 2013 the equity holdings of non-residents settled at USD 58.3 billion, decreasing by 6.7% compared to the previous month. Government debt holdings of foreign investors experienced a similar trend, reaching USD 56 billion, which represents 27% of total holdings. Foreign holdings of securities seem to mimic perfectly the movements of Turkey’s stock exchange index, which has stabilised since the free fall experienced after April 2013. Non-resident activity on the stock exchange market is highly volatile and recent data clearly shows how reactive these investors are to external factors and global investment sentiment. The general projection shows the aggregate capital flows to emerging markets will pick up in the last quarter of this year after a very weak third quarter. In this recovery period Turkey should focus on more reforms to restore economic confidence and decrease its short-term capital flow dependency. By The CEIC Database Team Discuss this post and many other topics in our LinkedIn Group (you must be a LinkedIn member to participate). Request a Free Trial Subscription. Back to Blog
19th December 2013 CEIC News@lert: Thematic Analysis of Capital Flows to Emerging Markets: Effects of US Tapering on the Turkish Economy