By Marshall Auerback, By Marshall Auerback, a market analyst and Research Associate at the Levy Institute. Cross-posted from Alternet.
Literally bridging Europe and Asia, Turkey has long appeared to refute Rudyard Kipling’s idea that “East is East, and West is West, and never the twain shall meet.” An EU Customs Union member with strong banking ties to the EU, and a member of NATO, Ankara has also been quite happy to involve Russia and China in its economic development. But the often delicate balancing act between these competing blocs may be thrown out of whack in the wake of the country’s current economic travails. Why? Per the tweet of Charlie Robertson, chief economist of Renaissance Capital, “Turkey is less than 0.1% of world equity markets. But #Turkey represents over 10% of NATO personnel – more than the UK and France combined – so US establishment (ie excluding Trump) will not want to lose Turkey.” So even if Ankara’s banking crisis does not trigger a global financial meltdown in the same manner in which, say, the Thai baht devaluation kicked off the 1997 Asian financial crisis, it may well fracture NATO’s foundations.
At first glance, Turkey’s current problems look very much like a typical emerging markets crisis: a financial bubble fostered ample global liquidity (largely dollar and euro-based), which in turn engendered a spike in Turkish borrowing and resultant domestic credit bubble. Fueled by historically low interest rates, Turkish corporations elevated gross foreign borrowings to the tune of $340bn, of which more than half is coming due this year. For a time, these foreign inflows triggered a consumer boom of illusory economic prosperity as Turks bought foreign goods with the proceeds and GDP boomed. However, the country’s current account deficit swelled to 6.5 percent of national output as a consequence.
And, much like the 1997 crisis, the recent collapse of the Turkish lira has exacerbated Turkey’s problems. The decline in the domestic currency (precipitated by President Trump’s decision to double tariffs on Turkish metal exports last week), along with the U.S. Federal Reserve’s ongoing interest rate hikes, have substantially elevated the cost of foreign debt servicing. Economist Brad Setser sets out Turkey’s problems starkly, noting that the country has “a one-year external financing need of close to 30 percent of Turkey’s pre-depreciation GDP, against 12 percent in total reserves and about 10 percent of GDP in foreign exchange reserves. And the bulk of Turkey’s maturing external debt is denominated in a foreign currency—it thus is a claim on reserves that cannot be depreciated away.”
But there is another variable here.
President Erdoğan badly needs to keep the Turkish “miracle” afloat, but he’s unlikely get the help he needs from the usual suspects, such as the IMF (which would likely force painful deflationary measures on the country as it did during the Asian financial crisis in 1997-98). He could well secure it from Russia, however, which would undoubtedly love to exploit any divisions in Turkey’s ties to the West. By the same token, Russia’s President Putin would tremendously increase his own domestic stature were he to pull off a pipeline/gas export deal with Turkey that a) brings in much-needed foreign exchange income for Russia and b) is a public slap in the face to the obvious U.S./Big Oil attempt to strangle Russian gas exports to Europe.
That may well motivate Putin to give Erdoğan an unusually sweet deal on a loan, on more weapons exports, and on the gas pipeline transit royalty money that could provide Turkey with valuable foreign exchange. In light of all this, a rupture with NATO may become an irresistibly tempting option for Erdoğan, as well as fulfilling Russia’s desire payback for 20 years’ plus of eastward expansion of NATO and the attempted promise of more to come in Ukraine (for whom NATO membership was publicly mooted as recently as 2014).
How did we get from there to here? The precipitating event that has caused the collapse of the Turkish lira (and the threatened collapse of its banking system) may well have been the recent imposition of Trump’s tariffs on Turkish metals, but the vulnerabilities festered and expanded long before this recent blow-up occurred between Washington and Ankara. Appreciating crude prices along with rising U.S. rates represent a lethal combination for a dollarized, oil-importing economy like Turkey. They have exacerbated the fragilities within the Turkish banking system, as well exposing scores of corporate borrowers of dollar-denominated debt to the risk of insolvency. Much like Hemingway’s bankrupt in “The Sun Also Rises,” then, Turkey’s implosion has come “Two ways. Gradually, then suddenly.”
Which banks are most affected? According to data from the Bank of International Settlements (BIS), “Spanish banks are due $83.3 billion by Turkish borrowers; French lenders are owed $38.4 billion; and banks in Italy are owed $17 billion, the FT reported.” More specifically, some 13 percent of Spanish Bank BBVA’s total loan book is tied up with Turkey (via its ownership of the Turkish bank, Garanti), Italy’s UniCredit (6 percent of total loans) and France’s BNP Paribas (2 percent of total loan book) all have significant Turkish exposure. This information is rapidly being priced into the respective share prices of these institutions, as concerns mount that their borrowers have not adequately hedged their foreign currency exposures, which increases risk of default with each new downward cascade in the lira (and corresponding write-offs by the banks themselves). As far any economic impact beyond Turkey goes, Peter Rosenstreich, a currency analyst at the online bank Swissquote, pointed to Chile, Mexico, Indonesia, Russia and Malaysia among those countries with high non-bank dollar debt as a percentage of GDP, which are now being reappraised by global traders.
The economic contagion impact is relatively easy to quantify. Less so, the political contagion, particularly the Russia/NATO variable, against a backdrop of deteriorating U.S.-Russia relations. As a result of the Helsinki Summit, there has been a subtle but important change in the Russiagate narrative: the narrative is now less about Trump colluding with Russia to influence the 2016 election (although the charge of collusion is still there) and is now more about Trump “aiding and abetting” Russia in its attack on American democracy and the Western alliance. Hence not only is Trump derelict in his duties, but his actions are also treasonous because he is working with the enemy. In many ways, this shift in the narrative is more dangerous than the collusion narrative because it means that the American intelligence community, and its sympathizers in #TheResistance, have been successful in establishing Russia not just as an enemy but as a clear and present danger to the U.S., leading to additional sanctions recently being imposed on Russia. This further incentivizes Moscow to exploit Turkey’s current difficulties, by offering Ankara a helping hand in exchange for greater geopolitical influence in the country.
Erdoğan made much of his alternative to “find new friends and allies” as he faced off with Washington this week, but the traditional means of arresting a credit crisis, an IMF-led bailout, is hardly appealing, given that the D.C.-based Fund is largely seen as an extension of American corporate interests and enforcer of the “Washington Consensus.” Assistance would likely come with hefty and painful strings attached (much as was the case in Asia in 1997). Erdoğan, therefore, will likely turn further eastward for help. Qatar has already stepped up with a pledge to invest $15 billion into Turkey’s financial markets and banks. China, which has already expanded its Mediterranean influence via its acquisition of Greece’s Piraeus port, will no doubt look to Turkey to expand further its “Silk Road” aspirations into Europe, although as the economist David Goldman notes:
“With the Turkish lira trading at 6.26 to the dollar, the whole of the Istanbul 100 equity index is worth just US$35 billion. If Chinese investors were to buy every share of every company on the stock index, Turkey would raise enough foreign exchange to cover just seven months of its current account deficit.”
Hardly enough to arrest the crisis; hence, a likely turn toward Moscow as well. Given NATO’s eastward expansion to Russia’s borders, Turkey’s geostrategic positioning doesn’t count for as much as it used to, which in part facilitates Washington’s newfound aggression (along with the perception by the Trump administration that Ankara is an increasingly unreliable partner, allegedly having reneged on a recent agreement to release an American pastor from detention). Judging from the president’s recent comments at the last NATO summit, what largely seems to count for the America Firsters are:
1) How does Turkey affect the defense budget, e.g., what weapons can we sell them and how many bases can we keep open there; and
2) Will they sign up for American Big Oil/Gas pipelines or Russian ones?
As far as the Russians are concerned, Turkey provides an opportunity for payback for 20 years of hostile American foreign policy actions—the eastward expansion of NATO to Russia’s borders, the U.S. support for the Maidan coup in Ukraine, the destruction of Libya, and the regime change crusade against Assad. These happened under previous American administrations, Clinton, Bush and Obama. There were of course many liberals and progressives who were uncomfortable with the Obama/Clinton foreign policy. But they are now uncomfortable acknowledging these concerns for fear that gives aid and comfort to Trump, as well as legitimizing his foreign policies. For that reason, those liberals and progressives, who might otherwise be open to more measured relations with Russia, are reluctant, even unwilling, to ascribe any U.S. responsibility for the current breakdown in U.S.-Russia relations, because it would be seen as disloyal to the resistance to Trump. Hence, the Clinton and the Obama years in particular are now beyond reproach. Which in turn exacerbates the prevailing Russophobia, and therefore gives Moscow yet more incentive to exploit the situation in Turkey. Especially as Russia sees the latest round of sanctions directed against it by Washington as a heightened form of economic warfare.
Picking off Turkey would be a major geopolitical win for Moscow, given that the country is viewed by Washington as key to the American strategy of splitting Eurasia and blocking Eurasian integration. Turkey is also essential to the U.S. strategy of encirclement of Russia—control of the Black Sea and countering Russia’s breakout with Crimea and Syria (as well as potentially offering the EU a piece of a pipeline venture that could mitigate Europe’s dependence on Russian gas); Turkey plays an equally important role for the U.S. in terms of supporting Takfiri/Salafist destabilization of Syria and Iraq and blocking the “Shia corridor from Iran to Hezbollah,” as well as breaking Israel’s isolation in the Middle East (beyond the tacit alliance with Saudi Arabia) while helping ensure Iran’s isolation. And finally, Turkey is viewed by Washington as an essential ally in controlling the eastern Mediterranean and the eastern Mediterranean energy resources.
Which means (as usual) that Trump’s “bull in a China shop” approach to foreign policy, will create unpredictable knock-on effects well beyond the usual run-of-the-mill emerging markets crisis. Emerging economies as a whole can all expect to experience some adjustment/dislocation as the global central banking community continues to withdraw monetary stimulus. But Turkey’s unique geopolitical position has virtually guaranteed that it will have ramifications that extend well beyond the balance sheets of a few exposed European banks or peripheral emerging economies. A break with NATO may well mean lost leverage for Turkey with the West, but Erdoğan may well think it is essential for his political survival—and that will trump other considerations for the time being. As for Turkey’s love of NATO perks, perhaps the Council on Foreign Relations still believes they are worth something (along with those few Kemalist Turkish officers who have survived the Erdoğan/Gulen purges), but it would be astonishing if the average Turkish voter thinks NATO is in his corner.
It is also worth recalling that while Kipling’s ballad did posit the idea of East never meeting West, he also acknowledged that “there is neither East nor West … When two strong men stand face to face.” Turkey’s crisis is conspiring to bring two modern-day strongmen, Erdoğan and Putin, together in a manner that could facilitate the very fracturing of the one institution, NATO, created to hold the Russian bear in check. Turkey is already up against the wall, deep in their currency/debt crisis, and all the U.S. is offering is a doubling of sanctions and more insults. One has to imagine that Putin can come up with a far more appealing deal for Erdoğan (and perhaps even one that makes money for Russia) than the Trumpian bludgeoning or the total Sinofication of Turkey’s economy.