Will Turkey Default on Its Debt? An In-Depth Look at the Turkish Debt Crisis

Turkey is currently facing a severe economic crisis that has raised concerns about the country’s ability to service its debt obligations. With high inflation a weakening currency, and rising borrowing costs many analysts warn that Turkey may be on the verge of a sovereign debt default. In this article, we’ll take an in-depth look at Turkey’s debt situation and analyze the chances of a potential default.

Turkey’s Rising Debt Burden

Turkey’s total external debt stands at around $466.7 billion as of early 2018. This includes debt owed by both the public and private sectors. The government’s debt is relatively low at around 40% of GDP. However, private sector foreign currency debt is very high in Turkey. Turkish companies have borrowed heavily in foreign currencies like the US dollar and euro. With the Turkish lira losing significant value against these currencies, servicing this foreign debt has become increasingly difficult.

In addition, Turkey has large financing needs to roll over existing debt and fund its current account deficit. Turkey’s gross financing needs are estimated to be around 25% of GDP in 2022. The government needs to borrow around $170 billion annually just to refinance maturing debt and fund the current account deficit. This heavy reliance on external borrowing makes Turkey vulnerable to shifts in global investor sentiment.

Factors Pushing Turkey Towards Default

Several factors suggest that the risk of a sovereign debt default in Turkey is elevated:

• Currency depreciation: The Turkish lira has lost over 40% of its value against the US dollar in the past year. This currency depreciation makes it much more expensive for Turkish entities to service foreign currency debts.

• ** Rising borrowing costs ** To defend the lira, Turkey’s central bank has aggressively hiked interest rates, with the benchmark rate currently at 24% Higher rates push up borrowing costs for the government and companies

• Foreign reserves declining: Turkey’s foreign currency reserves have dropped to around $87.9 billion, down from over $100 billion in 2021. Lower reserves constrain Turkey’s ability to intervene in currency markets to defend the lira.

• Investor sentiment deteriorating: Global investors have become increasingly wary of lending to Turkey, as seen in surging credit default swap spreads. Portfolio outflows from Turkey’s bond and equity markets have accelerated.

• Weak growth prospects: High inflation, high interest rates, and currency instability are likely to dampen economic growth in Turkey. Slower growth makes debt servicing even harder.

• Low policy credibility: Turkish authorities have frequently intervened in monetary policy decisions, undermining the central bank’s credibility. This makes investors less willing to finance Turkey’s large external funding needs.

How a Default Could Unfold

Many analysts warn that a balance of payments or sovereign debt crisis is a growing risk for Turkey. Here are some of the ways a default could unfold:

• Construction firms and real estate developers may start to default on their foreign currency debts as the lira depreciation inflates their obligations. This could spark a wave of corporate bankruptcies.

• Turkish banks may become increasingly unable to roll over their significant foreign liabilities, estimated at around $100 billion. A sudden bank funding crisis could force Turkish authorities to impose capital controls.

• As companies and banks come under pressure, Turkey may not have sufficient reserves to repay all foreign creditors. This may eventually force the government to restructure its sovereign bonds.

• A full-blown balance of payments crisis with the government unable to pay for critical imports like oil and natural gas.

• In a worst-case scenario, the economic crisis could spiral into a political crisis, with extended social unrest and institutional instability. This would make an orderly debt restructuring much more difficult.

What a Default Would Mean for Turkey

If Turkey cannot obtain enough external financing and ends up defaulting on its sovereign debt obligations, the fallout for the economy would be severe:

• Turkish borrowers would likely lose access to international capital markets for years. All Turkey’s dollar or euro-denominated bonds would need to be restructured.

• Turkish banks and companies shut out of foreign funding would need to sharply curtail activities. Asset fire sales may be required to repay foreign creditors.

• Turkey’s imports would likely need to be compressed through austerity measures. This would lower living standards for regular Turks.

• The lira could go into freefall, fueling runaway inflation and further eroding purchasing power. Price and capital controls may be imposed.

• Turkey’s weakened credit profile could also endanger multilateral assistance from bodies like the IMF. An IMF bailout with strict conditionality may be the only option.

In short, a sovereign default would deepen Turkey’s economic woes and could trigger a multi-year financial crisis and recession. The social and political consequences would also likely be severe.

Can Turkey Avoid Default?

Despite the heightened risks, Turkey still has some tools available to stave off default, at least in the short-term:

• Impose capital controls: Limiting capital outflows could help defend the lira and preserve foreign exchange reserves. However, this may unsettle investors.

• Secure alternate funding sources: Turkey is seeking funding from allies like Qatar to reduce reliance on private investors. But such bilateral deals are unlikely to fully close the financing gap.

• Aggressive rate hikes: The central bank could hike interest rates much higher to stabilize the lira. But this would drive up borrowing costs and worsen the growth outlook.

• Spending cuts and tax hikes: Fiscal tightening could reassure foreign investors but would also depress economic activity. Political resistance is high.

• Seeking an IMF program: An IMF bailout with strict pro-reform requirements may help restore confidence. But the government is still reluctant.

Outlook Remains Grim

While the above policy steps could buy Turkey some time, most economists argue that the overall trajectory is still very negative. Unless the government sharply shifts course and implements major economic reforms, Turkey may only delay, rather than prevent, a full-blown balance of payments crisis. With debt service costs rising and growth faltering, markets see an eventual debt restructuring as likely.

In conclusion, while Turkey’s government still has some unsatisfactory tools to ward off default in the near-term, the country’s heavy reliance on external financing makes it highly vulnerable to shifts in global risk sentiment. Barring a major policy change, Turkey seems headed towards a painful economic adjustment crisis, with distressed debt restructurings looking increasingly probable. The government should act urgently to restore investor confidence and put Turkey’s economy back on a stable footing.