Turkey’s alarming cash budget deficit in January

In a crisis-ridden 2020, the central bank's net foreign exchange reserves fell to minus $50 billion due to economic mismanagement and both the central bank governor and treasury and finance minister were replaced in November.

New governor Naci Ağbal and Treasury and Finance Minister Lütfi Elvan have pledged to work in coordination to reduce inflation, which now stands at 15 percent.

Ağbal has kickstarted the battle against inflation alone. He has promised investors transparency in addition to orthodox monetary policy, which was crowned with interest rate hikes. As a result, the Turkish lira appreciated significantly against the dollar even though inflation continued to accelerate. However, the economic errors of 2019-2020 and expansive fiscal policy are still haunting Turkey, underscoring that Ağbal’s efforts alone will not produce the desired results. When monetary policy is tightened, fiscal policy must also be tightened to have a disinflationary effect.

In 2019 and 2020, Turkey's fiscal policy was excessively loose.

Although consumer price inflation slowed to single digits after the interest rate increases introduced by the central bank after a currency crisis in August 2018, the government implemented an expansive fiscal policy throughout 2019 to help reverse economic contraction.

Murat Uysal, the former governor of the central bank who became a puppet of the government after he was appointed by President Recep Tayyip Erdoğan in July 2019, started to loosen monetary policy, delivering an astounding 1,200 basis points, or 12 percentage points, of rate cuts. He became one of the architects of the misguided economic policies that produced incredibly poor results last year - 15 percent consumer price inflation, depleted foreign exchange reserves, a budget deficit of 5 percent of economic output and a current account deficit of 6 percent of GDP.

Even though those responsible for Turkey’s economic calamity have largely disappeared from public view, their mistakes are all too tangible. Now Ağbal needs the support he was promised by Elvan to ensure that the steps he has taken in monetary policy produce long-lasting results.

But cash budget data announced by the Treasury on Friday makes for somber reading.

The Treasury reported a cash deficit of 26 billion liras for January, which amounts to a negative swing of 48.7 billion liras compared to the 22.7 billion surplus posted for the same month of last year. As can be seen in the above graph, the 12-month cash budget deficit has widened to 230.7 billion liras, significantly greater than December’s 12-month deficit of 181.9 billion liras. This is a huge gap that should ring alarm bells for everyone.

The primary cash budget recorded a deficit of 4.9 billion liras in January. The 12-month non-interest cash budget deficit jumped to 100.8 billion liras from 65.6 billion liras in December.

The Treasury’s budget revenues decreased by an annual 24 percent to 91.6 billion liras, while expenditure rose by 21 percent to 117.7 billion liras.

Among the many monetary and fiscal policy mistakes made last year was the rescheduling of the general assembly of the central bank to January from April. The central bank reports and distributes its profits at this annual meeting. By bringing forward the meeting in 2020, the Treasury raised a net 44.7 billion liras from the profit that the bank distributed, using the dividends to fund rising public expenditure.

The authorities have so far decided against rescheduling the central bank meeting in 2021, meaning the Treasury’s cash revenues were far less than in January last year.  Whether this choice reflects proper economic management by Elvan is not yet clear.

The net profit of the central bank totalled less than 20 billion liras last year due to lira weakness and after its net foreign exchange position turned negative. Perhaps this lower profit meant that Elvan decided not to repeat the policy mistake of last year and draw on central bank funds earlier than scheduled so as not to risk positive, but fragile investor sentiment towards Turkey.

Fiscal policy during the remaining 11 months of the year will clarify the intentions of Elvan and the government.

The breakdown of rising cash budget expenditures in January show that the government directed 96.6 billion liras to non-interest (primary) expenditures and 21 billion liras to meet interest payments on debt. The 8 percent annual increase in primary expenditures was equivalent to just over half of annual inflation. But interest spending surged by a staggering 179 percent. The headline 21 percent growth in total expenditure at first glance appears to be rooted in sloppy spending policy, but the main reason is the soaring interest expenditure bill.

It is important to give credit to Elvan for managing to limit the increase in non-interest expenditure in the first month of the year. However, it would be good if the former economic administration came clean on the damage caused to the economy, taking into account the severe depletion in foreign exchange reserves and that fact that state spending is now locked into paying for higher interest expenses at a time when the country’s budget resources should be directed to compensating for financial losses caused by the COVID-19 pandemic.

But Uysal and former Treasury and Finance Minister Berat Albayrak have yet to provide an explanation for their policy choices. Rather there is complete silence. Albayrak has disappeared from public life and Erdoğan has failed to hold either of them to account.

If we turn to the financing side of the January cash budget, the cash deficit of 26 billion liras was primarily financed by 25.3 billion liras in net foreign borrowing. Domestic borrowing was far lower at a net 7.3 billion liras. Thus, accounting for exchange rate movements in the first month of the year, the Treasury set aside 6.4 billion liras for its cash/bank account.

The Treasury, which has achieved one-third of its annual foreign borrowing target of $10 billion in January, will now give weight to raising money on the domestic debt market, according to a domestic borrowing programme announce for February to April.

Elvan, speaking to parliament during budget discussions in December, stated that the government reduced its domestic debt rollover target for 2021 to 120 percent from 149 percent last year. That means that 449 billion liras of the domestic debt that the Treasury will repay this year will be met and exceeded with 541 billion liras in borrowing from the market.

High interest rates, the average maturity structure of the bonds to be issued and the widening public deficit will mean that the Treasury will be crowding out the market in 2021.

Elvan does not expect a significant decline in the budget deficit to GDP ratio this year. Therefore, support for monetary policy from the fiscal side to reduce inflation will be limited from the outset. However, considering that spending will be channeled to meet higher interest payments, pressure on inflation caused by non-interest spending will be absent, barring any improvements on the revenue side in the coming months.

Turkey has survived 2020, a period of excessive public and private sector borrowing and irresponsible 1990’s-style economic management, but the damage is now there for all to see. The fallout from these policy mistakes will pull down average economic growth in Turkey in the years ahead.