Following the central bank governor replacement, Turkey suffered a huge net loss of portfolio investment in March. For the year as a whole, the country will continue to struggle to attract net capital inflows, although outflows should moderate. The current-account deficit will narrow, but remain dangerously large.
Turkey posted a current-account deficit of USD7.8 billion in the first quarter of 2021, down by USD1.1 billion year on year (y/y), but still large as a share of GDP. Vigorous merchandise export growth reduced the trade gap, which was responsible for the narrowing of the headline current-account imbalance.
On the other hand, the failure of tourism or other service exports to recover from COVID-19 in the first quarter – total service exports dropped by nearly 19% y/y – led to a sharp narrowing of the services balances. This worsening offset much of the positive impact of the smaller merchandise-trade deficit on the headline current-account balance.
Turkey also recorded a massive, record-setting net outflow of portfolio investment in March 2021, totaling USD 5.7 billion. Given the sharp plunge in the lira during March following the replacement of the central bank governor, the report of the strong net portfolio investment was not a surprise. The sheer size of the lost investment, however, reflects the deep market distrust of the new leadership.
In order to defend the currency in March, the central bank spent down foreign currency reserves by more than USD 6.8 billion over the course of the month. To begin to rebuild those reserves, the central bank once again engaged in heavy, short-term forward swaps, adding nearly USD 2 billion to its short-term obligations.
Outlook
In the weeks since the huge net outflow in March, Monolith anticipates that net capital outflows have narrowed significantly. The lira has stabilized. While this is likely a reflection of ongoing, central bank support for the currency, it also reflects an end to the huge outflows noted in March. Judging by weekly reserve data, the further drop of reserves and rise of short-term swaps from end-March to end-April has slowed considerably.
We expect that while the huge net outflows have not continued, the country is undoubtedly still leaking foreign capital. While not as headline grabbing as the huge net portfolio outflow, net inflows of foreign direct investment in the first quarter was down by more than USD700 million y/y, reflecting a growing distrust of economic policy making within Turkey. The steady decline of FDI has been occurring for years and looks set to continue throughout 2021 as well.
While the country struggles to attract foreign capital inflows, the current-account deficit remains dangerously large. Despite narrowing on a y/y basis, Monolith continues to forecast that the gap will surpass 4.5% of GDP for 2021 as a whole. The narrowing of the merchandise-trade deficit is likely to slow given the expected easing of monetary policy later in the year, which will fuel higher import demand.
Meanwhile, the tourism balance will deteriorate further as it is increasingly likely that the tourism sector will receive a much weaker bounce-back in 2021 than elsewhere in Europe because of lingering high COVID-19 infection rates and the slow roll-out of vaccinations. While the huge net outflows of capital have been stemmed for now, the country remains at high risk of an external financing crisis in 2021. The current-account deficit will remain dangerously high with net capital inflows still faltering.