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In 'rough year' for Turkey, economy falls but banks stagger on

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In 'rough year' for Turkey, economy falls but banks stagger on

Turkey had a turbulent year in 2016. Its gross domestic product contracted by 1.8% in the third quarter, the first shrinkage in seven years, following a failed coup d'état on July 15 that triggered an unprecedented assertion of power by President Recep Tayyip Erdogan, at the same time as the currency fell to historic lows and terrorist attacks grew in frequency.

Banks have yet to feel the pain, but asset quality is beginning to deteriorate and questions may arise over their ability to borrow money abroad, experts suggest.

"2016 was a rough year for Turkey," said Derya Okumus, an Istanbul-based associate director at EMF Capital Partners, a private equity firm. Despite a series of events that scarred Turkish society and harmed its economy such as the failed coup, the army's shooting down of a Russian fighter jet and numerous terrorist bombings, "the financial system held solid ... Turkish banks are used to dealing with crises."

Combined profits for the country's biggest six banks in the first nine months of 2016 exceeded those booked for the whole of 2015, but bad loans are also on the rise. Banks maintain high liquidity and solvency, Okumus said, but this might change if the economy does not settle.

"The currency remains unpredictable. The president is not supportive of interest rate hikes, which are the usual way to stop declines," she said.

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The Turkish lira lost about 20% of its value against the dollar in 2016, arousing investor concerns that the high foreign-currency leverage seen in the country might become unsustainable. In response, the central bank in late November increased repo rates by 50 basis points to 8% and overnight lending rates by 25 basis points to 8.5%. Simultaneously, the government urged the public and private sector to convert dollar holdings to lira in order to boost the domestic currency's value. Neither move had any lasting effect on the lira.

The president has reportedly said banks are betraying Turkish citizens by charging what he perceives as high interest rates on loans, and he has demanded the lowering of base interest rates despite a selloff in the currency.

The Turkish Statistical Institute's numbers show the Turkish services sector contracting by 8.4% in the three months to October 2016. Tourism income fell 32%, consumer spending 3.2% and agricultural output 8%.

"The government needs to take serious action to increase investor trust, ease tensions and provide security," Okumus said.

In response to the economic slump, the government vowed to extend $73 billion of loans to the private sector and encourage banks to restructure corporate loans, attempting to cushion the blow of some of its other decisions.

About 600 companies of all sizes were forcibly taken over by the state from those deemed to be sympathizers of exiled cleric Fethullah Gulen, whom Erdogan blames for igniting the failed coup. The administration also either seized or shut down numerous media outlets critical of the presidency and arrested more than 100,000 people suspected to have had an involvement in the failed coup, according to the latest estimates.

Erdogan has moved to change the constitution to bestow on himself considerably more executive power in 2017, in what international bodies including the European Parliament have warned is another step on the country's path toward authoritarianism. These changes will be tested in a referendum in April 2017.

These moves have made international investors more cautious, said William Jackson, an economist at Capital Economics.

"The political situation is concerning. Growing authoritarianism has slowed down the business environment, which makes me concerned about the banking sector," Jackson said. "The banks fund themselves to a large extent with credit from abroad. With investor appetite low, banks may struggle to roll over their short-term loans."

Between July 15 and Dec. 5, Turkish banks obtained syndicated loans of more than $7.5 billion from foreign lenders, a rollover rate of 95%, state news agency Anadolu reported. Türkiye Is Bankasi AS had the largest amounts of outstanding U.S. dollar debt as of Nov. 30, with $5.59 billion in senior bonds and $1.37 billion in subordinated ones.

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An interest rate hike by the U.S. Federal Reserve on Dec. 14 is likely to send the dollar's value up while further battering the lira, Jackson added. The Fed has signaled that more rate rises are likely in 2017, which will increase pressure on Turkish bank balance sheets and could drive up nonperforming loans.

"If customers also start struggling to repay, banks may restrain lending," Jackson said. "The Q3 GDP results are Turkey's worst reading since the global financial crisis."

"Turkey flashes red in all indicators of economic performance," he added, emphasizing high debt, high reliance on foreign capital and political risk. "I think this weakness will continue in 2017 and 2018."

Fitch Ratings has assigned Turkey's banking sector a negative outlook for 2017, a revision from the previous stable outlook.

"High levels of short-term foreign-currency wholesale funding leave banks exposed to significant refinancing risks and swings in investor sentiment towards Turkish country risks," the agency said, forecasting an aggregate NPL ratio of about 4% for 2016, up from 3.3% as of September-end.

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S&P Global Ratings is also worried about the funding of Turkish banks skewing toward international markets.

"A sudden stop to external financing would put considerable pressure on corporate balance sheets and weaken Turkey's growth, ultimately becoming a difficulty for the country's banks and public finances," the agency said in a Dec. 7 report that also criticized the president's frequent and overt statements aimed at influencing central bank policy.

Total foreign-denominated corporate debt in the country was estimated by the Financial Times at in excess of $200 billion.

As of Dec. 28, US$1 was equivalent to 3.54 Turkish lira.

S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.

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