Turkish lira's dive wrecks balance sheets, deters foreign investment

The lira's dive to a record low has badly exposed Turkish firms with foreign debts, forcing them to scrap some investments at a critical time as the country weathers a corruption scandal and tries to revive economic growth.

The weak currency is also denting profits made by foreign firms in Turkey, and deterring overseas investors who fear that uncertainty over monetary policy and domestic politics is creating too great a risk.

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Emerging markets across the globe are suffering a violent shake-out due, largely due to the U.S. Federal Reserve's decision to slow its program of printing money, much of which had flooded into emerging economies in search of better returns.

But the problems of Turkey, once an investors' favorite, are much deeper than most, and many of them are home grown.

The lira has lost about 16 percent against the dollar and 17 percent against the euro since Dec. 17, when the arrest of the sons of three cabinet ministers exposed a corruption investigation which threatens Prime Minister Tayyip Erdogan and his government's standing.

That is more than double the losses suffered by the lira's emerging market peer, the South African rand. Over the same period, it is down 7.45 percent against the dollar and 7.1 against the euro.

Erdogan has hit back at the police and judiciary, and accused a U.S-based Islamic cleric who has strong influence in Turkey of orchestrating the inquiry to unseat him.

Exacerbating this tense environment is a central bank which has persistently refused to raise interest rates to defend the currency. This followed strong public opposition to a hike from Erdogan, who is keen to boost economic growth as elections approach, forcing the central bank to burn through its foreign currency reserves to shore up the lira.

(Read more: Further gloom in store for lira)

The bank will hold an emergency monetary policy meeting on Tuesday, after its attempts to defend the lira with more subtle methods than a rate increase have all ended in failure.

All this bodes badly for an economy which has seen its stellar growth rates of 9.2 percent in 2010 and 8.8 percent in 2011 shrink to just 2.2 percent in 2012 and a projected 3.6 percent last year. The government badly wants more healthy growth in 2014, a year with local elections in March and a presidential poll in August.

How serious is the contagion threat of EM anxiety?

Deputy Prime Minister Ali Babacan called the lira's fall a "re-pricing process" due to the political turmoil and the Federal Reserve's decision to scale down its economic stimulus.

"The balance sheets of the government, banks and households are quite well protected against market volatility," he said at the World Economic Forum in Davos last Friday.

Debt cost

Turkey's leading business group TUSIAD estimates that within just one month Turkish firms' foreign debt has risen 25-30 percent due to the currency weakness and higher risk premiums which push up borrowing costs.

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Top executives say the lira's tumble to 2.31 to the dollar on Monday has played havoc with corporate planning. "We based our 2014 budget on a dollar exchange rate of 2.14 lira. Now everything is ruined," Tuncay Ozilhan, chairman of Anadolu Group, told Reuters at a TUSIAD conference.

Anadolu is one of Turkey's largest conglomerates which has interests from retail to energy, and owns brewer Efes.

"Now we are redoing the budget with a rate of 2.25 ... we will have to be very prudent this year. Any urgent investments or ones we had already started we will complete. The others we will have to decide on according to developments," he added.

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At the end of November, Turkey's private sector had $151.5 billion worth of long maturity debt, up 9 percent since the end of 2012, and $42 billion worth of short term debt, up 35 percent. The most recent central bank data shows 57 percent of debt was in dollars and 36 percent in euros.

Excluding the financial sector, foreign debt stood at $86 billion, almost two thirds of which is held by services companies and 37 percent by industrials.

Carmaker Tofas will also be very much more cautious with investments, CEO Kamil Basaran said.

Turkey's Sabanci Group said it still aimed to keep the budget it had completed before the graft scandal emerged. But the chairman of its retail and insurance arm, Haluk Dincer, complained: "There is no predictability right now."

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Even Turkey's exporter association TIM, which stands to benefit from a weaker lira, warned it would rather see a stable currency.

Suleyman Onatca, chairman of the Turkish Enterprise and Business Confederation, said the depreciation had caused difficulties particularly for small and medium-sized companies. "We hear banks are reluctant to reopen loans that have expired and have demanded additional guarantees," he said.

Onatca recalled an economic crisis in 2001, the most recent in a series that periodically hit Turkey before Erdogan's AK Party came to power. "We don't want to see companies falling like leaves as they did in 2001," he said, urging the government to reduce political tension.

"We want a Turkey which does not have a separation of powers problem, in which there is rule of law and confidence in every institution. This is the Turkey picture that domestic and foreign investors want to see," said Onatca.

Carmaker Oyak Renault said a weaker lira made its exports cheaper for now, but it could see input prices rise if its suppliers buy materials in euros.

Rainer Genes, the chief executive of Mercedes-Benz Turk, said his company was both an importer and exporter. "For us, the difficulty lies in the fluctuation, and combined with this in having less time for adaptation to the change, rather than in the weakness." he said. "The dimensions of the impact will become clear when the exchange rates are stabilised."

(Read more: Turkish Finance Minister: Protests a 'Hiccup' for Economy)

Boom years

Erdogan has overseen strong economic growth in Turkey since coming to power in 2002, transforming its reputation after a series of unstable coalition governments in the 1990s ran into repeated balance of payments problems and economic crises.

But its external financing needs are considerable - Barclays estimates them at $217 billion this year, more than five times the central bank's net foreign exchange reserves - and it is vital to be able to keep borrowing on international capital markets at reasonable costs.

"Some German companies contacted us recently because they wanted to know what was happening ... We said the trend is not very promising, and there are expectations the lira could weaken further," said Alper Ucok, head of TUSIAD's Berlin office.

Foreign Direct Investment (FDI) doubled between 2005 and 2006, peaking at $22 billion in 2007 before dropping due to the global financial crisis. It recovered but then fell again in 2012 to $12.6 billion.

Ucok said some foreign investors were hesitating. "Some companies have even put their investment in question. Industrial investors with large FDI are concerned and wondering about draft projects," he added.

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The head of TUSIAD warned last week about the impact on foreign investors of a recent spate of hefty fines against major companies and frequent legal changes in a public tender law. That earned him a rebuke from Erdogan that he was a "traitor".