With the Turkish lira in free-fall, Recep Tayyip Erdogan looks less like a prospective Ottoman caliph than a garden-variety Third World strongman whose patronage machine ruined the national currency. The Turkish prime minister's "neo-Ottoman dream" (Amir Taheri) for a "new Ottoman region" (Harold Rhode) reached its best-used-by date last December, when Turkey's stock market quadrupled in value from its 2009 crisis low. The deflationary wind that rocked American markets last week may flatten Turkey's.
MSCI investable Turkish index ETF (TUR)
Since then, the Turkish market has lost two-fifths of its value in
dollar terms, and the Turkish lira has fallen farthest of the world's major currencies, close to its 2009 crisis low. Turkey's financial unraveling has only begun. On March 1, I warned that Turkey was "a developing market to avoid". With the carnage in global markets, Turkey's problems barely made the back pages. But the strategic importance of Turkey's currency route will become a major theme for foreign policy during the next several weeks.
By contrast, other emerging market currencies have soared: Brazil's currency trades 70% above its 2009 low, and Russia's by 25%. Unlike the emerging countries with whom it competes, Turkey's current account deficit is out of control. It exceeds 10% of gross domestic product (GDP), about the same as crisis-ridden Greece and Portugal. Turkey's central bank has let the currency slide in a belated effort to correct the imbalance, but the lira's depreciation has backfired.
Turkey's supposed return to world power has captivated the foreign policy punditeska for years. In April 2009, President Barack Obama made Turkey his first overseas trip and hailed his "model partnership" with the country's Islamist leader as a pillar of America's relationship with the Muslim world.
During the first weeks of the so-called Arab Spring, countless commentators hailed the "Turkish model" as a template for democratic reform in the Arab world. Political models are like automobile models, I offered at the time: you can't have them unless you can afford them. Turkey was not a paragon but a rickety platform, I argued ( The Heart of Turkness), Asia Times Online, March 23, 2011). It turns out that even Erdogan can't afford the Turkish model. He has been living on borrowed time, literally.
Turkey's annual credit growth rate
Source: Central Bank of Turkey
Bank credit is rising at a 30% rate for households and a 40% rate for business, after adjustment for inflation. The country's GDP growth at an 11% annual rate in the first quarter - the world's highest - because the credit bubble boosted domestic demand.
"Turkey’s current account deficit is a frightening 8 per cent of GDP and is expected to hit 10 per cent before the end of the year," the Financial Times wrote August 4. "And the deficit is badly funded, with only about 15 per cent covered by foreign direct investment and the rest by portfolio flows."
Short-term debt held by banks and hedge funds, that is, finance most of Turkey's enormous deficit. The market is worried about Italy, whose debt has an average maturity of seven years. Turkey's foreign debt has short maturities and has doubled in the last year and a half.
Turkey's external short-term debt (US$ millions)
Note that Turkey financed its current account in part by offering high interest rates on short-term Turkish lira deposits. As the lira depreciated, Turkey had to borrow in dollars. The country's overall debt levels remain low compared to the weaker European countries, but the growth rate is alarming. To correct it will require a severe retrenchment of domestic consumption.
Erdogan's bubble recalls Argentina in 2000 or Mexico in 1994, where a brief boom financed by short-term foreign capital flows led to currency devaluation and a deep economic slump. In the advent of the June 12 national elections, which returned Erdogan as prime minister, the Turkish government bought votes through cheap credit. As the chart below makes clear, the bulge in credit growth drives the credit bubble.
Turkey: Total credit growth (horizontal scale) vs current account deficit (vertical scale), 2006 to present
Source: Central Bank of Turkey
As the total rate of credit growth surpassed the 30% mark, the chart shows, the current account deficit ballooned (that is why the trend line curves sharply downward). This implies that Turkish banks pumped so much credit into the economy that demand exhausted domestic sources, and drew instead on imports.
Financing higher consumption with short-term debt helps explain why Erdogan's Justice and Development Party (AKP) crushed its secular opposition in the elections. Erdogan campaigned on his success as an economic manager rather than his Islamist ambitions, with good reason, for most Turks cares more about material welfare than the AKP's religious agenda.
An economic slump would undercut Erdogan's ability to govern. His confrontation with his country's military leaders, who last week resigned en masse to protest the persecution of senior officers on fanciful allegations of political crimes, points to the deep fissure in Turkish politics.
For the time being, Erdogan has the upper hand: no longer will the mainly secular military will not overthrow a civilian government. But Erdogan's Islamists face entrenched and embittered opposition after three years of mass arrests of political opponents, journalists and military officers on flimsy charges of coup-plotting. The silent majority of Turks has gone along with Erdogan because the economy has improved, and his political fortunes could turn as suddenly as the Turkish currency.
Turkey has a few sources of economic strength. Its university system trains some world-class engineers and managers, but they comprise a thin stratum atop a mass of backwardness. Most Turks barely afford the elements of middle-class life, and many of them do not at all.
Only 26% of Turkish children graduate secondary school, compared to 44% in Mexico, 64% in Portugal, and 83% in Poland. Low-value added products (textiles, apparel, furniture, appliances autos) dominate its export profile. On the other hand, it is a net importer of food. Turkey's most important export is labor: 10 million Turks or Turkish-speaking citizens of the Central Asian states work in Russia.
Despite a few successes, what the Western media hailed as "Anatolian tigers" never got the Turkish economy up to take-off speed.
Now that the Cairo mob has turned against the "Internet-savvy" protesters on Tahrir Square, Libya and Yemen remain immersed in civil war, and Syria's Bashar al-Assad regime butchers civilians, there is not a single stable polity in the Arab world outside of Saudi Arabia, whose circumstances are unique. What I called "the Internet bubble in Middle East politics" in a February 16 essay (See here) has popped, to the embarrassment of the Western reporters who drooled over the Internet cafe-flies who prompted Egypt's popular rebellion.
If it turns out - as I predict - that the "Turkish model" differed little from the old Latin American borrow-and-bully model, we should conclude that no successful political model presently exists in the Muslim world. Starting with former United States president George W Bush, a credulous West embraced Erdogan as the exemplar of moderate Islam who would build a bridge to modernity.
This was delusional from the outset. In the long term, we are all dead, but Turkey is dead long before most of us. As I explained in the March 23 essay:
Time is not on Turkey's side. Educated Turks in the more developed West have a fertility rate of about 1.5, the same as Western Europe; the Kurds in the country's impoverished east have four or five children. Kurds, whose independence movement has cost tens of thousands of dead over the past 30 years, may become the majority within two generations. If Turkey holds together at all, it will be quite a different place.