Can Turkey’s Economy Endure a Syria Intervention?

Ankara risks not only diplomatic ties, but also economic ties with its neighbors and the rest of the world as it moves further away from its “zero problems with neighbors” foreign policy. Turkey’s economy and budget have been squeezed by the high priced bill from Ankara’s foreign policy maneuvers. The Turkish economy has increasingly become more fragile as the costs of the Syrian refugees reaches an estimated $8 billion, as tourism and other fallout from the downing of the Russian warplane reaches $10 billion, and as markets grapple with pressures from the US Federal Reserve’s normalization process. Furthermore, the Turkish state’s curfews reinstated in the southeastern parts of Turkey caused hundreds of businesses to shut down—especially in Diyarbakır and Şırnak. Turkey’s “quality” of current account financing and its macroeconomic indicators also show a negative trend. With already high inflation, a current account deficit, a stagnant GDP, a plunging Turkish lira, and high external debt, can Turkey’s economy afford an extensive intervention in Syria?

1. Fiscal Effects

Due to low oil prices, Turkey’s current account deficit narrowed by over $10 billion in 2015 (it now stands at $32.2 billion). Even though Turkey’s headline fiscal metrics are still favorable, the underlying dynamics point to a different story. Turkey’s 2015 balance of payments show that the country indeed attracted $16.5 billion in foreign direct investments, an increase of 32 percent from 2014. According to Turkish Central Bank’s (CBRT) 2015 Balance of Payments statistics, however, the quality of financing—or how the deficit is financed—increasingly came from two major components: (1) The Turkish Central Bank’s own reserves, which fell by $11.8 billion throughout 2015, and (2) from the so called “net errors and omissions” component in Turkey’s balance of payments account, which showed the capital inflows of unknown origin rising by $9.6 billion—an unusually high level of unknown financing, which disrupts the country’s “quality of financing” in its current account deficit.

The balance sheet’s portfolio investments component also showed an outflow of $9.3 billion in Turkey’s total investments portfolio, the first outflow since the 2008 financial crisis (from an inflow of $20.8 billion in 2014). Economists call it “hot money,” which refers to the flow of funds from one country to another to earn a short-term profit on interest rate differences or exchange rate shifts. These speculative capital flows can move quickly in and out of markets, potentially leading to market instability—meaning that $9.3 billion of “hot money” in the form of equities and bonds left the Turkish markets. By comparison, only $3.7 billion left the country during the 2008 economic crisis.

With Turkey’s increasingly aggressive stance on Syria—including rumors of Turkish intervention already underway—its ability to maintain fiscal stability is questionable. Prolonged lower growth in emerging markets will place added pressure on Turkey’s sovereign creditworthiness. These are just some of the fiscal components that will directly get affected if the country chooses to engage more aggressively into the Syrian conflict, which is one of the reasons why the government has been announcing minimum wage increases (close to 30 percent) in an effort to boost GDP and its fiscal metrics.

2. Currency Effects (The Lira’s Plunge)

In addition to fiscal effects, additional pressure will fall on Turkey’s currency markets. Analysts marked the Turkish lira, which has already lost 25 percent in value last year against the dollar, as one of the top losers among emerging market currencies. With the scarcity of the Turkish lira (against the dollar or euro) in Turkey’s domestic markets, the Turkish Central Bank (CBRT) has been leaning on its Open Market Operations (OMO) facility to supply short-term liquidity directly into Turkey’s banking sector, drying up the CBRT’s reserves. In addition to the OMO, the CBRT uses the state-owned Eximbank (which provides loans to Turkish export companies) to boost the lira’s liquidity. Eximbank gives loans in Turkish liras (indexed to foreign currency) and realizes these loans in dollars upon settlement. The amount the CBRT provides through its OMO facility reached 96 billion liras (approximately $32 billion) in January 2016. This is not a sustainable amount given that the country’s reserves stand at 127 billion liras. If tensions in Syria escalate, the market’s short-term liquidity needs will increase and the CBRT will eventually have to increase its interest rates—an action that President Erdoğan and his economic advisers have long opposed thanks to their focus on investment-oriented growth. If the CBRT continues to pump liras into the Turkish markets, this will most likely cause severe damage to Turkey’s banking sector. Banks would face difficulty in reflecting the financing costs in their interest rates, as most of the OMO goes to a few selected banks.

The Turkish lira has lost 35 percent since the beginning of 2014 and 65 percent since the beginning of 2013 against the dollar. If the lira continues to plunge, Turkey’s banks and private sector will also face difficulties in paying back their foreign currency debt. The majority of Turkey’s external debt belongs to the private sector, soaring to 87 percent in December 2015 (from 64 percent in 2007; public sector debt remains at 12percent). According to figures recently released by the CBRT at the end of 2015, banks owed $78 billion in short-term debts. Other private sector companies have short-term foreign debts of $37.4 billion, totaling a short-term external debt stock of $115.6 billion, which refers to the total that must be paid in one year or less. Given such an outstanding bill, the Turkish government would be ill-advised to embark on what would undoubtedly entail a costly military intervention in Syria.

3. New Governor of CBRT is Crucial for the Economy

The third factor against a possible ground operation involves the uncertainty surrounding the possibly imminent departure of CBRT Governor Erdem Başçı. Global markets are closely monitoring whether Başçı will be replaced by another central banker when his term expires on April 19, 2016, which would signal a change in Turkey’s monetary policy. President Erdoğan is known for openly criticizing CBRT policies, calling Başçı a traitor for not cutting interest rates more aggressively. This politically sensitive issue lies at the center of major differences between the choices of Erdogan’s economic team and Prime Minister Davutoglu’s circle, which prefers that Başçı continue for another term.

In its last meeting on February 23, Turkish CBRT decided to maintain a wait-and-see approach, holding its benchmark interest rates at 7.5 percent. This policy keeps the interest-rate-corridor unchanged between 7.25 percent and 10.75 percent, despite the rising inflation pressures. For how long can the CBRT continue supplying liquidity with its OMO operations facility is the key question that will determine the daily needs of the Turkish domestic markets.

The fiscal pressure, currency slide, and uncertainty surrounding the central bank all make financing an intervention in Syria an economic nightmare that could do more damage to the Turkish economy than its worth. If Ankara chooses to pursue a more aggressive foreign policy towards Syria, Turkey will be fighting a battle on many fronts—the toughest on its economic front.

M. Hande Akmehmet is an independent economist with a focus on Turkey, the Middle East, and emerging markets.

Image: Turkey's Central Bank Governor Erdem Basci arrives at a news conference in Ankara January 28, 2014. (Reuters)