The last few weeks have been particularly hectic for the Turkish economy, already in the midst of a currency crisis.

The Central Bank of Turkey issued a long-awaited and surprisingly high interest rate hike of 625 basis points on September 15, raising the policy rate to 24% — up from 17.75, a move that boosted the currency before it dropped in value against the US dollar once again.

And finally on Thursday, the government’s Medium Term Program for 2019-2022 was announced under a revamped title: the New Economic Plan (NEP).

Experts and markets had been waiting for the rate hike, and the NEP to see if the government could prevent further depreciation of the Turkish lira, get inflation under control, and stop the currency crisis from turning into a debt crisis and stagflation.

The plan saw Turkey reduce its growth projections to 3.8% from 5.5% for 2018, the same day the Paris-based Organization for Economic Co-operation and Development (OECD) cut its growth forecast for Turkey to 3.2%. It also called for 76 billion Turkish lira worth of cuts to public spending.

But while the revised growth forecast and cuts seemed to show the Turkish government is accepting the seriousness of the economic problems the country faces, the “new” plan is far from new and full of contradictory promises and figures.

No plan for debt

The New Economic Plan was delayed for 10 days as Minister of Finance and Treasury Berat Albayrak held a flurry of meetings with representatives of the corporate sector and the banking sector. The delay, observers hoped, was for the government to come up with a concrete way forward for the banks and corporate sector to restructure mounting debt, as well as a direction for fiscal policy.

Bloomberg reported the planned debt restructuring would likely involve only firms with a debt level of 100 million and higher. Commentators argued this would mean small and medium-sized firms would be left bankrupt. Another report said some 100 companies applied for bankruptcy, among them two major export companies: 95-year-old Burak Aluminum and 58-year-old Teknik Aluminum.

On Wednesday, the Banks Association of Turkey revealed local banks had signed a Financial Restructuring Framework Agreement, which would support clients struggling to repay their liabilities.

All of this led observers to hope the NEP would include measures to support debt restructuring.

But when the plan was finally unveiled the next day, there was no such detail.

While the markets appeared to calm on the news that the government accepted lower growth rates and public spending cuts, the missing piece is now the main worry for the Turkish economy.

Growth slows

Turkey’s GDP rose 5.2% in the second quarter of 2018 before snap elections, thanks to generous public expenditure and positive net exports. While that figure is quite impressive given global economic conditions, a deeper dive into the data shows consumers and investors are starting to reach their limits.

After one of the best growth performances among developing countries in the first quarter of 2018, Turkey’s economy began showing signs of a slowdown.

The construction sector — the engine of the economy throughout all AKP governments — and real estate activities seemed to bottom out. While construction growth is down to 0.8% in the second quarter from 6.6%, real estate activities are down to 0.2% from 3.4%.

The latest data from the Turkish Statistical Institution on housing sales in August indicates that increasing interest rates is particularly harmful for the construction sector.

Housing sales dropped 12.5% relative to August of last year. The drop was due to a sharp decrease in housing sales with mortgage credits, which contracted 67.1% relative to August 2017.

Forecasting fantasy?

The government’s key economic targets in the New Economic Plan include a 20.8% inflation forecast for 2018, up from an unrealistic 13.4%. The unemployment rate is estimated to reach 11.3% by the end of 2018 and 12.1% in 2019. It was 10.4% in August.

The government promises to have a budget deficit of only 1.9% by the end of 2018 and to keep it below 2% for the next three years. In order to achieve these budget targets, it has instituted public spending cuts of 76 billion lira and revenue increases of 16 billion lira in 2019 to keep the deficit below 2%.

Nearly 40 billion out of 76 billion in spending cuts will be from public investments, and another 13 billion will come from social security expenditure. The public investment cut amounts to a 36% decrease.

Growth in gross fixed investment had already halved to 3.9% in the second quarter, especially in machinery, and the private sector has been quite busy with debt repayments, so the budget cut in public investment will guarantee a shrinking of the economy in 2019.

The OECD has already reduced its growth forecast for Turkey 2019 by 0.5%, almost 2 percentage points lower than the new plan projects.
The government is also promising to reduce the current account deficit to as low as 3.3% in 2019 and below 3% as early as 2020.

The government is counting on a depreciated Turkish lira for this optimistic current account balance, which will hopefully fuel exports and tourism revenues.

However, real foreign exchange rates used to estimate GDP forecasts seem to stay below inflation estimates, suggesting the Turkish lira is expected to appreciate in real terms for the next 3 years. It is unclear how exports will increase enough to reduce the current account deficit to the levels in the NEP with alleged real appreciation in lira.

Moreover, with public investment cuts and highly indebted export companies, production activities will probably decline, making these current account deficit targets too ambitious.

There was no concrete plan for debt restructuring in the NEP except for stating that the banking sector’s financial structure will be alleviated and thus the real sector will get access to credit with reasonable costs. The plan promised that a policy set would be introduced to deliver restructuring for existing loans.

There was no assessment in the plan about how turning private debt via these restructuring plans into public debt will affect the economy and taxpayers. But they will be the ones who will pay the burden with public cuts and tax increases.

Living on foreign investment

Throughout the new plan, the government exhibits hope for an end of struggles for foreign investment. With the serious cut in public investment and the promise for further public savings, the government seems to have no other policy to offer.

There is no indication in the NEP that the government has made any mistake or there have been faults in its economic design based on debt-driven consumption.

The final measure the government introduced on September 19 supports this observation. The government has significantly reduced the required limits for foreigners to acquire Turkish citizenship to encourage foreign investment.

The lower limit of fixed capital investments for foreigners to acquire Turkish citizenship has been reduced to $500,000 from $2 million. The deposit requirement of $3 million in Turkish banks has also been lowered to $500,000. Real estate requirements have dropped to $250,000, down from $1 million.

Turkish state television presented this new regulation with an excited headline: “Investing in Turkey just got a whole lot cheaper.”

Last of the ‘fragile five’

Turkey in 2013 was classified by Morgan Stanley as one of the “Fragile Five” economies, too dependent on unreliable foreign investment to finance its external deficit and ambitious growth projects.

Since that time, only Turkey remained in the group, determined by key indicators including current account balance, foreign exchange (FX) reserves to external debt ratio, foreign holdings of government bonds, and inflation.

The Turkish government has done nothing to improve these indicators; on the contrary, the indicators have worsened since 2013.

With GDP for 2018 down to $763 billion, Turkey’s external debt stock to GDP ratio will hit 61%. That puts Turkey above the 60% threshold widely viewed as a signal of an external debt crisis. Yet neither the rate hike nor the New Economic Plan seems to seriously address the struggles the Turkish economy is going through.

The Turkish lira has lost 67% of its value since the start of 2018. When consumer inflation reached 18% in August, headed to hit more than 20% by the end of the year, the central bank had no choice but to increase its rates.

The first reaction to the rise was positive and the lira started to appreciate, reaching 6.05 against the US dollar from the levels of 6.45 before the rate hike. However, the impact of the rate hike did not last long and on September 19, it rose as high as 6.40, briefly stabilized around 6.25, then rose again to 6.29 after the NEP was released.

The reason behind the limited impact of the rate hike is the high FX debt burden of the corporate sector. While total FX liabilities of the non-financial corporate sector is $335 billion, the non-financial corporate sector’s FX open position amounted to $221 billion in May. Short-term external debt stock reached $120.6 billion after increasing 2.1% in July. And while the banks’ short-term FX debt declined by 0.8% to $66.7 billion, other sectors increased their FX debt by 5.9% to $53.8 billion. The vast majority (81.3%) of total FX debt stock belongs to the private sector.

To make things worse, capital flight from the country that started in March continues. Foreign investors sold a net $59.6 million in Turkish stocks and $96 million worth of government bonds in the week of September 14. As the Central Bank of Turkey rightly said: “FX debt increases firms’ vulnerability to exchange rate shocks, and leads banks to make sudden FX purchases in periods of heightened uncertainty with a view to reducing the exchange rate risk on debt repayments.”

Turkey, meanwhile, has one of the highest rates of inequality in the world, as measured by the Gini index which has been on the rise since 2014. In 2017, the index rose from 0.404 to 0.405. But the NEP contains no reference to the distributional impacts of the actions the government plans to take, despite serious public spending cuts. The government seems only to promise lower income and higher disparity in income distribution for its citizens to solve its economic problems.

President Recep Tayyip Erdoğan continues to insist there is no economic crisis in Turkey, telling a visiting delegation of investors from the United States on Wednesday that the situation was due to “mere manipulations,” and Turkey is richer and more effective than it was two decades ago.

Households do not reflect Erdogan’s optimism. The Turkish consumer confidence index was 59.3 in September, down from 68.3 in August, the biggest monthly decline on record.

It is unclear how the measures outlined in Turkey’s New Economic Plan will solve the country’s structural external deficits, which stem from its dependence on imports. With the nation on the eve of a serious economic crisis, it is a question a three-year plan should have answered.