Turkey: The Trouble with Debt-Driven Growth

Turkey has had strong economic growth over the past 20 years. Unfortunately, much of this expansion has been driven by debt-fueled infrastructure spending. This excessive accumulation of debt has had significant repercussions that have created serious imbalances in Turkey’s economy.

As the global economic outlook has deteriorated amid rising inflation, the ongoing pandemic and geopolitical instability, the headwinds facing Turkey have only strengthened. As a result, the country’s current economic crisis is likely to intensify further.

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Growth driven by infrastructure

After a “lost decade” in the 1990s, Turkey embarked on a prolonged period of robust economic growth. In fact, its GDP expanded at an annual rate of 4.6% from 2002 to 2020. However, this expansion was not generated by its usual engine—household consumption—but by infrastructure spending and other capital expenditures. While this boosted growth, it also imposed several long-term problems on the economy:

1. High and growing economic imbalances

Turkey adopted loose monetary and fiscal policies to fuel its economic expansion. That growth was achieved, but accompanied by high inflation and excessive indebtedness. Turkey’s CPI rose to a staggering 54.4% in February 2022 and is still rising. This has reduced the purchasing power of consumers and the overall competitiveness of Turkish industry, not to mention the value of the Turkish lira.

Turkey CPI, year after year

Chart showing Turkey CPI (YOY)
Sources: TUIK, Earthen Street Capital

2. High debt

Turkey’s GDP growth has been facilitated by excessive leverage. The gross debt of the country’s non-financial sector has more than quadrupled, from $211 billion in 2000 to $871 billion in 2020. In comparison, the country’s GDP expanded by only 270% in dollar terms of the USA. As a result, the total debt burden of the economy increased from 77% of GDP in 2000 to 129% in 2020.

Turkey’s non-financial sector debt as a percentage of GDP

Chart showing Turkey's non-financial sector debt (as a percentage of GDP)
Sources: BIS, Earthen Street Capital

In addition, much of this debt comes from external sources: the country’s total external debt is approximately 60% of GDP. For a country with twin deficits, this debt trajectory is unsustainable.

3. Weakness in traditional economic drivers

Turkey’s infrastructure spending has not benefited other sectors of its economy as much. The country’s main economic driver, household spending, has weakened during the 20-year expansion, falling from 69% of GDP in the first quarter of 2000 to 55% of GDP in 2020.

Turkey’s gross fixed capital formation and personal consumption expenditure as a percentage of GDP

Chart showing free cash flow and personal consumption expenditures as a percentage of Turkey's GDP
Sources: TUIK, Earthen Street Capital

Net exports have also stagnated as a share of GDP. As a result, the economy has become even more dependent on infrastructure spending and debt expansion.

An unsustainable path

Turkey’s economic model depends on the availability of easy credit, regardless of the country’s ability to repay it. Amid the darkening global outlook and worsening domestic situation, such credit will not be so readily available. And this will only further distort Turkey’s economy.

With the rapid fall of the lira, the country’s external debt is already becoming more expensive, and amid monetary tightening in the United States and Europe, credit will become increasingly difficult to obtain.

Turkey’s current account balance as a percentage of GDP

Chart showing Turkey's current account balance as a percentage of GDP
Sources: IMF, Earthen Street Capital

Rampant inflation, a heavy debt burden and high unemployment mean that the Turkish economy faces considerable instability. Meanwhile, consumer spending declines and the country’s economic competitiveness appears to be declining as it trades less with developed markets and more with emerging markets.

Continuing on the current path of debt-fueled growth will only exacerbate Turkey’s problems: indeed, it could lead to a deeper recession or, worse, prolonged stagflation. External events such as rising inflation and the war between Russia and Ukraine will further drag on Turkish growth.

Previous economic crises in Turkey in 1958 and the 1970s and 1990s followed a similar pattern of excessive inflation, high current account deficits, and a rising lira. History suggests the need for caution.

Worksheet for Inflation, Money and Debt Puzzle: Application of the Fiscal Theory of the Price Level

The government doesn’t help

The economic policies of the Turkish government do not indicate that the necessary course correction is being made. The nation’s leaders seem to prioritize political goals over economic stability. In addition, the lack of independent institutions makes it more difficult to achieve a balanced policy.

A cautionary tale?

Turkey’s economic growth path offers a lesson for other developing nations that rely on debt for growth: An over-reliance on leverage creates economic distortions that can have profound consequences.

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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.

Image credit: ©Getty Images/Sami Sert

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Dhruv Goyal, CFA

Dhruv Goyal, CFA, is the founder of Earthen Street Capital. He specializes in global macro research and investments in sovereign bonds and currencies. He has over 15 years of industry experience and has previously worked with Nationwide Insurance, Wisconsin Alumni Research Foundation and CUNA Mutual Group in the United States. He holds an MBA from the University of Wisconsin-Madison and is a CFA charter holder.

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