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A Turkish Scenario for the Romanian Economy?

A Turkish Scenario for the Romanian Economy?

No. 7-8, Sep.-Dec. 2017 » Bridging News

Since the Social Democratic Party’s (PSD) ascent to power in 2012, which was sealed by the 2016 Romanian parliamentary and local elections, some commentators and opposition leaders have compared the actions of Social Democratic leaders – such as former PM Victor Ponta or party chairman and Chamber of Deputies President Liviu Dragnea – not only with those of their peers in Hungary and Poland, but also to those of Turkish President Recep Tayyip Erdogan.

This was mainly in connection with PSD’s perceived push to control and subordinate the justice system – which it considers politically biased – as well as its larger efforts to upend an ambiguous constitutional balance between key institutions. It considers these, ironically given the country’s post-communist constitutional history, as stacked against its interests because of the center-right presidential winning streak starting in 2004. Other comparisons can be made, such as its drive to disregard civil society critics, or even attempt to silence the almost permanent street protests of the last year and a half, which it designates as a diversion or manipulation either by opportunistic opposition politicians who cannot accept defeat or sometimes even by ill-wishing, destabilizing or hostile foreign forces. Finally, the PSD government-Erdogan regime comparison is related to its desire to open up Romania’s economy to China’s state managed model of capitalism – thought of as more resilient in light of the 2008 crisis – and to welcome China’s global outreach strategy – which it views as broadly aligned, or at least compatible, with Romania’s national interests (a fact reminiscent of the country’s late 1960s and early 1970s, post-Stalinist, policy of balancing alliances within a more “multipolar” Communist Bloc).

Despite inherent flaws in such “big brush” analyses seeking to identify a “new authoritarian wave” spanning from North America to the Pacific Ocean, the comparison could prove more apt or at least more appropriate at the moment with regards to PSD’s economic policy. 

Turkey’s economic woes 

Turkey is currently in the grips of a classic balance-of-payments crisis. Since the beginning of the year, its currency, the lira, has lost 38.42% of its value, plunging the TRY/USD exchange rate from 0.2636 USD on January 1st to just 0.1623 on August 27. Although the decline of the lira has apparently been halted for the moment, following energetic measures by the Turkish central bank and financial authorities to dry out the short-selling market of foreign exchange as well as the announcement of a 15 billion USD sovereign investment deal into Turkish assets by Qatar, the ending of the crisis is far from sight. Indeed, the Turkish currency recovered a bit from a low of 0.1438, reached soon after US President Donald Trump announced a doubling of tariffs on Turkish exports of steel and aluminum (a punitive measure for the arrest of an American pastor accused by the Turkish government of taking part in the anti-Erdogan coup of July 2016), but its decline resumed on August 28 when it fell again below 0.16 USD.

Despite inherent flaws in such “big brush” analyses seeking to identify a “new authoritarian wave” spanning from North America to the Pacific Ocean, the comparison could prove more apt or at least more appropriate at the moment with regards to PSD’s economic policy.

As is usually the case with balance-of-payments crises, the Turkish crisis-scenario took some time to build up and materialize, but then unfolded rapidly and the turmoil could be severe and long-lasting before it bottoms out. Almost a decade of uninterrupted, volatile but high growth rates, spurred by cheap money inflows and a lax internal monetary policy, have created the conditions for a full-blown crisis, amplified by political risk. What is remarkable regarding the Turkish crisis – which mixes politics, geopolitics and economics – is that the main driver of the drama is represented not by the public sector (as was generally the case with Greece and the eurozone sovereign debt crisis of 2012, which currently risks repeating itself with Italy), but by the private sector indebtedness. With a government debt-to-GDP of 28.3% at the end of last year and a budget deficit of only 1.5 % of GDP, the Turkish economy, which grew by 7.4% last year, seemed superficially to be in good shape as early as the beginning of the year, despite mounting inflationary pressures reaching double digits foretelling problems ahead. However, Turkey’s total external debt, which counts both the private as well as the public debt owed to foreign creditors, amounted at the end of 2017 to 53.3 of the country’s GDP – well above the 40% debt-tolerance threshold established empirically by economists Carmen Reinhart and Kenneth Rogoff for emerging countries.

The plunge in the value of the Turkish lira has made servicing or repaying this debt very expensive or close to impossible, forcing the country to cut back on its 5.5% of GDP 2017 current account deficit (which by now should have roughly halved). According to Guillermo Calvo, a leading thinker on the topic, the loss of imports, along with capital flight, widespread bankruptcies and credit default, will further spread the contraction in Turkish economic activity well beyond the immediately exposed sectors. It will be awhile before any rebound based on more competitive exports and a gradual pick up of investment in undervalued assets shows up on the horizon, bringing the economy back into balance and resuming growth from a much lower GDP level. 

Parallels 

It will be awhile before any rebound based on more competitive exports and a gradual pick up of investment in undervalued assets shows up on the horizon, bringing the economy back into balance and resuming growth from a much lower GDP level.

Despite the current discourse in the financial press or among financial analysts pointing to the contrary, balance-of-payment crises are not exclusive to emerging countries. For instance, the United Kingdom, an advanced economy, went through at least two in recent history, first in 1976, when the country had to call in the International Monetary Fund (IMF) to keep the pound sterling from sinking in value, and then in 1992, when Britain was forced out of the European Exchange Rate mechanism which preceded the establishment of the European single currency. But emerging countries are indeed more prone to this type of crisis, especially because their currencies do not enjoy reserve or safe haven status on the international financial markets. Consequently, they are forced to borrow more in foreign currency, which makes them extremely sensitive to domestically-driven swings in interest rate policies in those creditor countries, as well as to international investor sentiment. The late 20th century globalization is thus pockmarked with emerging country balance-of-payment crises. The early 1980s Latin American debt crisis was followed by the 1997 East Asian crisis, which was followed by the 1998 Russian crisis, which also engulfed Central and Eastern Europe more broadly and Romania in particular during the 1996-2000 center-right CDR coalition government. 

The Romanian situation 

The ever deeper geopolitical rift between the AKP-ruled Turkey and Western countries, as well as spats with major NATO Allies such as the Unites States, in particular over the future shape of war-torn Syria and its stateless Kurdish minority, are lacking in the case of Romania. The closest equivalent are the spats between the PSD government and European institutions and governments as well as American officials over what constitutes the rule of law and an independent judiciary. However, the economic picture for Romania is at first sight not that different from that of Turkey.

The current account deficit, which nearly closed after the 2009 crisis-measures from an unbelievable height of 13.8% of GDP in 2007, is on the upside again, reaching 3.4% at the end of 2017, a 38% increase over the previous year. Although the total external debt ratio has constantly decreased since the Crisis, it still amounted to almost half of the country’s GDP (49.8%) at the end of last year. The public debt ratio has also fallen from near 40% of GDP to 35% in 2017, but the budget deficit is on the increase, reaching the upper maximum permissible in the European fiscal compacts for the last two years (3% in 2016 and 2.9% in 2017). The annual growth rate for 2017 was a very proud 6.9% of GDP, again mirroring the Turkish economy’s 7.4% of GDP 2017 growth rate. However, one major and consequential difference between Romania’s and Turkey’s key macroeconomic indicators shows up in the inflation rate, although the former’s actions of late – such as poorly funded increases in public wages, pensions and spending more generally as well as discomfort with central bank independence and tightening monetary policy – have triggered anxieties even in this regard. In 2017, Romania’s inflation rate shot up to 3.3% from a negative 0.5% a year earlier, well below Turkey’s 11.9% to be sure, but still above the central bank’s target or Euro convergence criteria, with an even higher inflation rate of 3.8% optimistically forecasted for the current year.

Romania and Turkey are at the moment in opposite positions on the balance-of-payments crisis risk curve.

The significant difference in the inflation rate between the two countries indicates that – despite more or less similar exposure to foreign indebtedness and spending gaps – Romania and Turkey are at the moment in opposite positions on the balance-of-payments crisis risk curve. The moderate heating up of the Romanian economy due to the PSD government’s expansionary fiscal policy still reflects growth, although that is petering out, with an unemployment rate falling below 5% at the end of last year from 5.9% the previous year, while Turkey’s double digit inflation rate reflects overheating and runaway inflation, with unemployment stagnating at 10.9% at the end of last year, the same as in 2016, but up from 10.3% in 2015, 10% in 2014 and 9.1% in 2013. 

Conclusion 

Romania might face some sort of contagion effects from the turmoil on the Bosporus.

Nevertheless, vigilance is still required, in economic matters just as in political matters. Balance-of-payments crises usually exhibit large contagion effects, with investors pulling liquidity out of entire regions once a single country is faced with a plunging currency and capital flight even if its neighbors have sounder macroeconomic fundamentals. Romania is classified as a Central and Eastern European (CEE) country in the financial industry’s lexicon (and a European Union member), while Turkey occupies a rather ambiguous position between European country groupings and the Middle East, due to geographic proximity. There are also “open fires” elsewhere in the emerging markets, such as Argentina first and foremost. Despite this, Romania might face some sort of contagion effects from the turmoil on the Bosporus. In any case, the side effects of the unfolding crisis in Turkey will surely be felt in Romania as well, since Turkey is actually Romania’s first commercial partner from outside the European Union, with bilateral exchanges of around 5 billion euros per year, direct and indirect Turkish foreign investment totaling 4 billion euros, almost 15.000 Turkish owned firms registered in Romania and over 4.000 Romanian nationals or dual citizens living in or around Istanbul as well as a notable flux of student and other forms of cultural exchanges.

 
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