Twin deficits: A tale to end in tears

The participants were equally divided on a no deal and a deal right before the October World Bank-IMF meetings in Istanbul. The minister contributed to the uncertain atmosphere by declaring both that there wasn’t a consensus in the government on a deal and that a deal was being worked on. However, one thing is certain: The government has decided to keep the Fund at a literal stand by, only to be called upon when deemed necessary. But necessity could come under many guises.

With the yearly figure expected at 1-2 percent of GDP, the once-feared current account deficit has turned into a ghost of Christmas past. Notwithstanding the optimistic tourism revenues and oil price assumptions underlying this projection, it is clear that the deficit will stay at low levels. However, financing could still be an issue: The Balance of Payments has so far been balanced out thanks to the relative resilience of corporate borrowing and the puzzling errors and omissions item, part of which are probably repatriated deposits from abroad. With these likely to be weaker going forward, a significant reserve rundown should be expected without an IMF deal. September and October, with hefty external debt repayments, will be the key months.

On the fiscal side, the government seems to have been encouraged by the Treasury’s ability to manage the high borrowing, with a deficit of 66.6 billion liras (no pun intended) and a rollover ratio of 120 percent in the pipeline. However, congratulations should go the catcher, not the pitcher: With bonds starting off from a low base in their balance sheets, credit demand falling and risk rising while deposit growth holding up and regulatory changes allowing them to shift their Treasuries to hold-to-maturity portfolios, the banks would have turned to bonds even without Central Bank’s (CBT) excess liquidity through open market operations and aggressive monetary easing. Of these, only liquidity is here to stay, so even with an IMF deal, it is a much less bond-friendly world out there. As a more general point, notwithstanding the relative strengths of the Turkish economy in the region, the lira does not offer the attractive risk-adjusted returns it once did.

My only consolation is Finance Minister Mehmet Şimşek’s declaration that the government is working on structural fiscal measures such as revenue administration, municipality expense control and a fiscal rule, which would help keep the deficit under control for this year and ensure the sustainability of debt dynamics.

However, the recent actions of giving yet another tax break to municipalities and authorizing the Grain Board to issue special government securities make the Minister’s remarks sound like an April Fool Day’s joke.

The latter, which is also clever accounting as it will not show up in the budget books, brings to mind the aftermath of the 2001 crisis, when similar issuance by the CBT and banks had resulted in a significant deterioration of debt dynamics that took a few year to sort out. In any case, I still have to figure out why the government would go for a virtual IMF program without the credibility (and the money) of a real one.I am not sure which of the factors above will break down first. But when one does, we are likely to see the unfolding of a drama that will leave not only the viewers but also the participants in tears.

Emre Deliveli is a freelance consultant. His daily Economics blog is at http://emredeliveli.blogspot.com/.