/ 29 September 2016

Turkey’s credit downgrade could be a bad omen for South Africa

A man waves Turkey's national flag during the Democracy and Martyrs Rally
Lungisa Fuzile. (Waldo Swiegers/Bloomberg/Getty Images)

Emerging economies looked on, clutching one another’s arms and grimacing, as their Turkish peer was dealt its junk status blow by rating agency Moody’s last Friday.

Like the climax of a B-grade horror movie, you couldn’t tear your eyes away from the screen despite its predictability.

Part of the morbid allure was thanks to the incredible theatrics of Turkey’s President Recep Tayyip Erdogan, who reacted similarly to how you would imagine Rumpelstiltskin did after the miller’s daughter guessed his name.

“I don’t care at all; they’re making mistakes and they’re doing it intentionally,” Erdogan fumed in an interview. “Whether you’re honest or not, Turkey’s economy is strong.”

The president called the downgrade dishonest and “contrary to economic ethics”. In perhaps his biggest rant, he likened the decision to the failed coup that his government managed to stave off earlier this year.

But apart from the theatrics, South Africa had a particular interest in seeing how it all went down. After all, we have been flirting with the possibility of a downgrade for the better part of a year now. Turkey’s news was a grim reminder that we could be next.

It’s also a reminder that economic growth is not the be-all and end-all that Erdogan purports it to be.

Both countries, using countercyclical policy measures, managed to avoid a recession during the global financial crisis. The preceding years had been economic heydays for both: foreign investors parked their money on our shores, and growth and prospects were generally strong, if at times a little volatile. But the past few years have marked a fork in the road for South Africa and our European counterpart: we have seen an epic slowdown in economic activity whereas Turkey has managed to keep things relatively upbeat.

Growth in South Africa has slowed progressively since 2013, with overall economic activity contracting by 1.2% in the first quarter of this year. Banks and analysts revised their growth forecasts for 2016 to about 0.8%.

After seeing impressive growth for the most part of a decade, the Turkish economy also slowed down to a gross domestic product expansion forecast of 2.8% for 2016 and 2.5% for 2017, according to Barclays Bank.

In a desperate bid to address growth concerns, Erdogan made some flip-flops in his political stances, including attempting to ease regional geopolitical tensions with Turkey’s neighbours.

Those and other efforts were partially successful on the economic front, because Turkish productivity last quarter increased by a relatively healthy 4.8%. But in the process, the president stirred up internal unrest – and then the game-changer struck: an attempted coup by a faction in the Turkish armed forces. Rebels cited, among other things, the country’s loss of international credibility as a reason for the takeover attempt.

Erdogan wrested power back and a massive purge ensued, with nearly 45 000 government employees suspended and 10 000 people detained. The Turkish lira plunged 6% in the days following the coup.

“The attempted takeover and the harsh response have hurt investor confidence,” said Nader Habibi, professor of the economics of the Middle East at Brandeis University, in the weeks following the event. The risk of unrest and internal upheaval was on the rise.

His words proved prescient. In its statement outlining reasons for last week’s downgrade, Moody’s said: “The risk of a shock arising as a result of the country’s weak external position has become more pronounced, given the combination of persistently high political risks and volatile investor sentiment.”

In South Africa (to the despair of some), there has been no coup. But many believe that President Jacob Zuma responded to a threat to his own power by unceremoniously sacking respected Finance Minister Nhlanhla Nene in December because of his opposition to a huge nuclear deal and corruption at the state-owned airline.

“Nenegate” was the South African economy’s short-term game-changer. The rand fell below R15 to the dollar and foreign investors pulled out money in boatloads – an estimated R500-billion, in fact.

Under pressure to appease the markets, Zuma reinstated former finance minister Pravin Gordhan four days later and the rand, like the lira, eventually recovered. But the ongoing tension between the president’s power base and the treasury has dismayed investors, with the rand’s volatility partly a result of this.

“People are getting tired of the circus and investors don’t like uncertainty,” Warrick Butler, the head of emerging-market spot trading at Standard Bank, told Bloomberg. “The rand is the poor cousin [in the emerging markets] because of the politics.”

And the movement of foreign capital last year shows that South Africa is, indeed, a poorer cousin than Turkey. Foreign direct investment (FDI) in South Africa plummeted 74% to $1.5-billion last year, a far steeper decrease than experienced by the rest of the continent, according to the United Nations’ global investment trends monitor.

In stark contrast, FDI in Turkey grew by 32% from the year before, reaching $16.5-billion. Despite a cocktail of issues brewing, the country attained its highest-ever annual FDI figure since the global financial crisis.

Turkey has been able to meet its debt obligations but, now that it is junk territory, its government will need to offer higher interest rates to entice investors to buy government bonds. Several analysts estimate that it will cost as much as 50% more to service its debts.

Turkish government 10-year bond yields jumped by 3.23 percentage points to 9.60 on the Monday after the news of the downgrade broke. Although the uptick was sharp, it is still a way off from its all-time high of 11.29, reached in February 2010. And the better rate attracted new buyers. On Monday, the Turkish bond market had the highest number of bidders it has seen in two years.

South African 10-year bond yields also saw a 0.7 percentage point increase on the news. On Monday, they stood at 8.63. South Africa’s all-time high, however, is almost double that of Turkey’s: it reached 20.69 in August 1998.

Analysts have repeatedly raised concerns about South Africa’s large trade deficit. Like Turkey, the country services this debt with foreign capital inflows. And so the threat looms.

“The risk of a sudden, disruptive reversal in foreign capital flows, a more rapid fall in reserves and, in a worst-case scenario, a balance of payments crisis has increased,” Moody’s said about its Turkey decision.

Both countries have ostensibly aggressive growth policies, intended to shore up and sustain the economy during adverse conditions. But the Erdogan administration has remained dogmatically committed to this singular aim, with all other considerations apparently taking a backseat. Take, for example, the fact that the Turkish monetary policy committee keeps cutting interest rates, despite the fact that inflation has recently hovered between 8% and 9%, breaching its upper target limit.

In contrast, the South African Reserve Bank has raised the local repo rate in small, steady increments over the past 18 months. The main reason cited: to curb inflation.

Both South Africa and Turkey have earmarked tourism as a key sector of GDP. In South Africa tourism makes up about 3% of overall GDP and in Turkey it is 4.4%.

In this area, Turkey has come off second best. Attacks blamed on jihadists and Kurdish militants (preceding the coup) had already seen tourism take a sharp downward turn, with foreign visitors down almost 37% in July. Visitors from Russia, considered one of Turkey’s key tourist markets, were down by 93%, according to official statistics. In the last quarter, the number of visitors dropped by almost a third.

In sunny South Africa, tourism statistics are much more favourable, in spite of Nenegate, isolated killings leading up to the local elections, violent service delivery protests and crisis-level student unrest. In fact, tourism has seen a happy surge: in the first half of 2016, it increased by 18.6% compared with last year.

In Turkey, there is political volatility, abuse of government power, an overreliance on foreign debt and weak institutional frameworks, but decent economic growth.

In South Africa, there is internal unrest, abuse of government power, a large trade deficit and sluggish economic growth, but more robust institutional frameworks. At this point, the ratings agencies seem to favour our mixed bag. But the movie is far from over.