Mustafa Vehbi Koç, the CEO of Koç Holding A.Ş., a Fortune Global 500 corporation and the largest conglomerate in Turkey, is one of those people who call attention to the risk of booming private debt stock to the financial stability in Turkey. Talking about his expectations for the economy in 2012, he told a reporter during an interview back in December that expanding the private debt stock raises questions on the sustainability of the high economic growth Turkey recorded in the last two years.
This is not the first time Mr. Koç talked about this issue. In November 2008, when the world was suffering from the financial crisis due to a mortgage meltdown in the US, he echoed similar remarks during a speech to Koç Holding dealers in the northern city of Fatsa. He said that if the private sector becomes distressed, this would lead to problems on the balance sheets of banks. It is interesting to note that the same argument was repeated by members of the opposition in Parliament. The main argument centers on the premise that banks in Turkey are more vulnerable because private industry is exposed to a high debt crisis.
In other words, what Mr. Koç was trying say is that we might see a repeat of the 2001 crisis, which started with failing banks and subsequently engulfed the private sector in Turkey, but the other way around. Since the banking and financial sectors are very strong in Turkey thanks to comprehensive restructuring and the strict regulations the country has adopted since 2001, and because public finances are in order, the advocates of doomsday scenarios for the Turkish economy can only point to weaknesses in other areas, starting with the burgeoning private debt, which adds more fuel to the chronic current account deficit (CAD) in the country. But if one examines the private debt stock in more detail, one will have a hard time finding a real cause for alarm at the moment.
First, let’s look at the numbers. The total external debt of Turkey is $309.6 billion according to the Treasury report of January 2012. The private sector owns 66 percent of this debt, which corresponds to $203.8 billion. In the figures for 2010 (data on 2011 have not been published yet), the total debt to gross domestic product (GDP) ratio is 39.5 percent, of which 25.7 percent belongs to the private sector while 1.6 percent is owned by the public sector. In terms of the quality of the debt, the private sector has $80 billion in short term financing and $123.6 billion in long term financing.
The Central Bank of Turkey has been responsible for monitoring private sector debt in Turkey since 2001. When I talked to Central Bank Governor Erdem Başçı over breakfast last week during his visit to our office in Ankara, he explained the difficulties in identifying which money is for investment in Turkey and which is simply for a cash transfer among company holders. If it is simply a cash transfer within the company and/or among owners using various schemes, this might easily be recorded as debt in the balance sheet according to accounting rules when in fact it was not. The difficulty comes from the vague guidelines the Organization for Economic Cooperation and Development (OECD) uses for the statistical definitions of wire transfers.
For example, we know that many companies and wealthy individuals in Turkey keep cash accounts abroad to finance their business and stock market trading operations in Turkey to benefit from the taxation regime, which is favorable for international financing. They use the cash assets they keep in foreign bank accounts to secure credit and instead of bringing in their own money, they prefer to borrow from foreign banks in order to use loopholes in the Turkish taxation regulations. That means a sizable portion of the private external debt in Turkey was secured by collateral in these cash deposits. As such it does not pose any risk to Turkey or the foreign banks that extend credit to Turkish businesses.
Some of the private debt comes from the long-term syndicated loans the companies have obtained to purchase large state enterprises in Turkey’s privatization tenders. For example, Mr. Koç’s conglomerate acquired a majority stake in the Turkish Petroleum Refineries Corporation (TÜPRAŞ), Turkey’s largest petrochemicals company, in a public tender at a cost of $4.1 billion. Instead of using its own cash reserves to pay for the purchase, Koç Holding obtained a $1.8 billion long-term loan from a consortium of banks using project revenues as collateral. Finance Minister Mehmet Şimşek cited TÜPRAŞ as an example during the 2012 budget debates in Parliament in October of last year, saying that private companies may secure financing abroad because of long-term payment plans. “Sometimes debt was even incurred just to obtain tax advantages. Hence I believe it should be beneficial to partially evaluate these figures [regarding the private debt stock] within this framework,” he told members of Parliament.
Indeed, most analysts do not see a problem in managing the private debt stock in Turkey, underlining the fact that the bulk of that debt comes from export credit lending or intra-company cash transfers from parent to a subsidiary in major international companies. They also stress that while the total private debt soared to $204 billion in the third quarter last year, up from $64 billion in 2004, the private sector has also grown rapidly, increasing assets to a level of a healthy liability to assets ratio. This debt was secured using cash, assets or projected revenues as collateral, analysts point out.
Science and Technology Minister Nihat Ergün looks at it from a different perspective. He says that foreign lending to private industry in Turkey should be hailed as a good thing rather than a curse for the country. “Is it not a good thing that private industry obtains foreign financing based on its own securities?” he asked, adding that the government did not offer any guarantee for these loans. He praised the fact that Turkish companies have grown to the point where they can easily obtain funds from abroad using their investment schemes, cash reserves and entrepreneurial spirit. “Turkish firms have become credible companies abroad. Therefore, there is no need to worry [about private debt stock]; rather, we should be pleased,” he explained. Minister Ergün also added that the private sector was able to invest $43 billion in the economy in 2002 as opposed to $164 billion in 2010.
Governor Başçı agrees with the government analysis of the private debt stock but adds a word of caution to the debate. He says the rapid increase in private loans may be a problem for Turkey. He recognizes that the debt stock will further increase considering the low debt levels private industry has maintained over years, but he says there is plenty of room to accommodate credit expansion. His main concern centers on the quality of loans, advocating the shift from short-term financing to longer terms. “Accumulation of debt should be spread throughout years,” he said, stressing that the central bank has taken the necessary measures to insure the expansion of credit at reasonable levels.
He believes the bank has to have a role to play in stabilizing the exchange rate because of the exposure of some Turkish companies to borrowing rates and foreign currency fluctuations. He came out triumphant from the battle in reversing the rapid fall of the Turkish lira last month by using an unorthodox policy mix of keeping the bank’s main policy rate low despite high inflation while selling billions of dollars to stabilize the lira at the same time. Sticking to an unconventional policy of widening its interest-rate corridor, which allowed the bank to constantly shift the cost of borrowing between 5.75 percent and 12.5 percent rather than raising benchmark interest rates, the governor made sure the bank has enough leverage to respond to immediate challenges.
Since Başçı has proven that his unconventional approach was the correct one in the face of many international analysts including those at the International Monetary Fund (IMF), who warned that Turkey may experience a hard landing and even a recession later this year, I would rather go with the governor’s assessment for the expansion of private debt.