Dilemmas in and after the time of the pandemic

AS I HAVE CLAIMED BEFORE, an old style balance of payments crisis isn’t in the cards. However, an FX funding squeeze is a flat, open, crystal-clear reality, and there is more to come. It isn’t only the current account deficit that matters, nor do tourism revenues – or lack of it thereof. It is the stock-flow-debt service dynamics that count more. As such we are talking about at least USD 200 billion for the next 12 months, and funding is both scarce and expensive. Not only have net reserves eroded, and the swap lines add up to c. USD 60 billion now, of which c. USD 20 billion is one-month, but public banks sold their FX ammunition last summer, and they are giving FX-denominated Treasury notes in lieu of hard currency. Actually FX-denominated securities count as FX deposits in accounting items, but they are only claims redeemable on a coupon basis or of zero-coupon after they mature – if they are specifically issued as non-tradeable assets. Well, in many ways this is reminiscent of the aftermath of the 2001 Crisis.


Now FDI doesn’t even count as a serious source of funding. Portfolio flows don’t meet financing requirements either. Hence, it should be mainly banks and Treasury securing overseas funding, bond issuances and FX-deposits held abroad. As a result, CBRT net reserves are eroding. There isn’t ammunition enough to smooth the FX market, and I strongly believe, TRY interest rate hikes have either already past the threshold of defending the currency or are very near to that point. As we know full well, the relationship between the local currency ex ante real rate of interest – a proxy for the ‘equilibrium rate of interest’ given inflation – and the exchange rate isn’t monotonic. Furthermore, it can be non-linear. The problem is in fact no longer the issue of stabilizing the currency via the interest rate. The problem is to convey a clear signal to the effect that the CBRT is no longer ‘behind the curve’. And by ‘curve’ I mean almost everything this time around. For one thing, inflation may not have peaked yet. Moreover, a second clear signal ought to come from the banks front. As the Halkbank case is pending, but the verdict is approaching, any sizeable fine that may follow would have serious consequences. One has to take into consideration many risks and they emanate from various factors.

Obviously, these are only the necessary conditions. Political realignment and overall risk avoidance are also key. In short, a clear signal like “yes, we are aware of the urgency of the situation” is warranted. I think we may be close to the moment of reconciliation with economic and international realities, only to face later new geopolitical challenges that lie ahead, i.e. Iran, and all that. The sooner the better of course, given that solvency risks for some corporates have already surfaced. This is one reason why FX reserves were depleted last year. But we ought to consider this: many businesses were at peril when the Credit Guarantee Fund was invented in 2017. That was a delaying device. As a side effect, the credit surface had been translated and risk management meant little back then. Last year, the banking sector had to incur risks that go way above the grade of 2017. Now there is a mounting NPL risk, there is a long-term loss that has been incurred via low interest rates – below break-even – forced lending, and there is FX risk. And the Fed may add insult to injury if it begins tapering before envisioned. El-Arian claimed it should, but it wouldn’t any time soon. Maybe it will. Both cost of debt and cost of equity will rise in the next years.


There are times risk – or in this case measurable uncertainty if we stick to the distinction of Frank Knight between risk and uncertainty – depends on a common factor. In 2004-2005 for instance Brazil and Turkey performed similarly, their equities moving in almost complete daily correlation for 18 months. The fundamentals of those two countries were totally different though. At about the same time, other assets also performed hand-in-hand in the two countries. It looked like Turkey was one composite asset index and Brazil another and the two composite indices also moved together. The common denominator was international flow of funds at a time when there was talk about a “global savings glut”. Today, Turkey looks more and more like one composite asset driven by a composite risk coefficient. It is the country risk tout court. It is composed of both policy risk and political risk. Purely economic and financial risks are all derivatives of these two in the short-run.

Back in 2018, as the country risk rose in an environment unfavourable to the EM credit, the cost of corporate FX debt has risen to 175 bps above the benchmark interbank rate, and the amount of syndicated debt dropped by a hefty 26% in the first four months. Overseas funds have been pulling back then. Compared to the current situation, the risk was lower; at least we had FX reserves. Today, it isn’t only CDS, it isn’t only credit risk, but it is a composite risk phenomenon and can only be addressed to at that level. The risk is not company-specific or idiosyncratic either.


Inflation truly matters now, perhaps more than ever in the last decade or so. Because electoral studies reveal that people care much more about jobs and income, i.e. growth, than inflation ahead of whatever elections that loom on the horizon, governments tend to favour growth at the expense of inflation. Also, because inflation is only an index and various Gini groups may have different inflations depending on their spending patterns – which is surely the case today because food inflation stands at c. 30%, whether the head-on CPI is 16% or 18% may not change approval ratings. However, when inflation climbs and nears ‘moderate inflation’, i.e. 15-20% (‘head-on and official’, one must add to qualify which inflation one is talking about) there is a risk for an inflationary spiral to form and you can face ‘runaway inflation’. Actually, inflation is probably much higher than what ‘moderate’ means already. Anyway, moderate inflations are notorious for tipping off either way in a short span. Moderate inflation is like a flat yield curve, so to speak. Again, at official c. 16%, inflationary pressures are being felt by households, and cost-push inflation is still rampant. The 31% domestic producers’ price inflation implies 15% CPI/D-PPI ‘scissors’ and this isn’t a normal pattern. I think 18-19% CPI in May wouldn’t surprise anyone. That has already had a clear impact on all sorts of loan rates. I repeat: it is far from being the right time for a rate cut, and it may never be a right moment for quarters to come.


Note that in the manner suggested by Hélène Rey (London Business School) in 2015, international monetary shocks, such as the Fed’s drastic U-turns, weigh more than domestic conditions in terms of its impact on interest and exchange rates. They do so to such an extent that the infamous Trilemma of Robert Mundell boils down to a dilemma. Actually one of the most recent CBRT working papers supports this hypothesis. What is to be done is clear and obvious if you stick to financial account liberalization, because the Monetary Trilemma takes over from there and you can only try to control either the interest rate or the exchange rate – but not both. And if you stick to international financial integration, then the Financial Trilemma takes over and you can only either command the macro-prudential macroeconomic policy set without any international influence or choose not to do it that way and keep financial stabilization intact –but not both. Given financial openness and international financial integration, you have to act in tandem with the international financial community, adjust your macroeconomics accordingly and raise the interest rate if need be. It is that simple. Then you may probably concur with Hélène Rey’s predicament to the effect that the Monetary Trilemma is in fact a dilemma because international monetary policy spillovers – from the Fed in the first instance – constrain small open economies’ monetary policy choices, it actually strengthens the argument. In that case, there isn’t even a Trilemma. What is left is just a necessity once you are open to financial flows; there is no choice. If so, ‘raising the interest rate’ or ‘cutting it’ are only manners of speaking here because the interest rate is clearly endogenous.

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