International Finance

A technical post on the q2 global reserves and balance of payments data … wonky.

Reflections on the Global Financial Crisis, through the lens of the U.S. balance of payments.

Turkey is in a bit of financial trouble. It isn’t clear that today's rate hike on its own will be enough. The rate hike will make the lira a bit more attractive to foreign investors (and will raise the return on domestic residents holding lira deposits too).  But it will squeeze the banks—who run a funding mismatch in lira. And higher rates on lira won’t change the fact that Turkey, its banks, and its firms, have more dollar and euro debt coming due than they have liquid external reserves. Turkey is also a NATO ally of the United States, and, at least in theory, possibly a future member of the European Union. Though in both cases, Turkey’s actual position is, let’s say, rather complicated.  The United States and Turkey disagree more than they agree, despite being treaty allies. And there is no realistic possibility Turkey will be admitted to the European Union anytime in the foreseeable future. In the past, though, Turkey’s geopolitical significance would have added to the pressure on the United States to support an IMF package to bolster Turkey’s reserves.   And Turkey fits into the IMF’s current policy template for the kind of countries that deserve large scale financial support relatively well (e.g. it fits into the Fund’s exceptional access policy framework*), at least in some ways. It has a solid underlying fiscal position, even if it needs a bit of long-term fiscal adjustment and likely faces a significant bank recapitalization bill. Its government doesn’t have that much debt, and most of Turkey’s treasury debt is denominated in lira rather than dollars and euros. It’s just a bit short of external reserves, and its banks have an awful lot of short-term external debt.    Erdogan, of course, doesn’t want to go to the IMF—so the question of whether the United States would support a Turkish rescue is a bit theoretical for now. The more interesting question for the moment is whether Turkey might find a geo-strategic coalition of the willing that would be able to mobilize sufficient financial support to make a real economic difference without requiring that Turkey go to the IMF. The answer, I think, hinges on how much money Turkey needs—and of course just how much risk a coalition of the “friends of Turkey” might be willing to take. And to make it interesting, in a financial sense, I think you have to leave China and Europe out.   China has—in my view—about a trillion more reserves than it needs. And it has substantial lending capacity outside of its central bank as well: the annual increase in the external lending of China’s state banks recently has been about $100 billion a year. For all intents and purposes, China can mobilize financing if it wants to on a scale comparable to the IMF. But there is no sign for now that China has any interest in doing so. The institutional and political barriers to any European rescue are much higher. The EU doesn’t have a big existing facility that is well-suited for Turkey (see Claeys and Wolff of Bruegel), and it almost certainly would never lend without the IMF’s participation. But if it had the will to create a special Turkish Loan Facility, the underlying financial capacity is there—especially if lending were combined with pressure on European banks to maintain their existing exposure to their Turkish subsidiaries and other Turkish borrowers.  What of Russia and Qatar? Russia has about $450 billion in total reserves—$370 billion in foreign exchange reserves, and around $75 billion in gold. That’s about $75 billion more foreign exchange than the post-sanction, post-oil shock low of around $300 billion. And Russia’s reserves have been growing—they are up over $25 billion in the last year, thanks to funds set aside in Russia’s oil stabilization fund—though this inflow has temporarily been suspended to support the ruble. Finally, Russia runs a sizeable current account surplus too, one that should easily top $75 billion in 2018. For all that, lending Turkey $100 billion (well over 5 percent of Russia’s GDP) would be a financial stretch—foreign exchange reserves would dip below $350 billion if a large part was made available upfront. But in my view, Russia probably could join together with others to cover a $50 billion package while maintaining a decent reserve buffer of its own.   And if Russia wanted to structure a portion of its aid a bit more creatively, it also could help Turkey over time by convincing Gazprom to provide Turkey with gas at below market prices… Qatar is really, really rich. It has a huge amount of gas (and some oil too) relative to its population, and has accumulated one of the world’s largest sovereign wealth funds. It is again running a current account surplus too thanks to higher gas prices, even with some rather large domestic spending commitments. Plus Qatar historically hasn’t been afraid of leverage—its state backed banks could chip in. The only question is whether Qatar has enough spare foreign exchange lying around that it could lend a large chunk to Turkey while remaining in a financial standoff with its neighbors. Qatar has already promised $15 billion to Turkey—though it isn’t clear over what time frame. And in a bad scenario, Turkey needs foreign exchange today, not a promise of loans to fund new buildings and the like over time. The form Qatar’s support takes matters as well as the size.   Between them, though, I suspect Russia and Qatar likely could match the $50 billion the IMF provided Argentina over three years—the comparison works because Argentina is an economy that is (broadly) comparable in size to Turkey. But would that be enough? Well, it depends. Turkey’s current account deficit was running at a roughly $50 billion annual pace before the latest fall in the lira. It has been attracting about $10 billion in FDI, leaving a gap of $40 billion that the market currently isn’t willing to fill in. However, the current account deficit is clearly now falling sharply. Auto sales were down by 50 percent in August. The lira has already fallen significantly, Turkey’s government has promised a bit of fiscal consolidation, Turkey’s banks seem to have more or less stopped lending and Turkey is heading for a potentially sharp recession. Robin Brooks of the IIF thinks Turkey’s underlying current account is now heading toward a surplus—I want to see confirmation, but it seems safe to assume that the Turkey no longer needs to worry about financing a current account deficit. What then is Turkey’s financing need? Well, it depends. Turkey has about $180 billion external debt coming due, according to the latest central bank data. And most of that is denominated in foreign currency. The Central Bank of Turkey’s foreign exchange reserves are now just over $75 billion, and the banks may have about $25 billion (or a bit less now) in foreign exchange of their own. I left out Turkey's gold reserves, in part because they are in large part borrowed from the banks and unlikely to be usable.   Turkey’s banks also have about $160 billion in domestic foreign currency deposits. To be absolutely safe with that funding structure, Turkey would need to hold about $300 billion in reserves, or maybe $250 billion if the rule would be a year’s external rollovers and all domestic sight deposits in foreign currency. It obviously falls far short.   Let’s assume that Turkey’s foreign currency deposits stick around. Historically they have. And well, if they don’t, Turkey is clearly in big trouble. The potential drain from the $180 billion in external debt coming due depends on the rollover rate—if everyone renews their lending and Turkey’s current account goes away, Turkey would be able to survive on its current reserves. And it depends a bit on how carefully Turkey guards its reserves. All Turkey owes non-residents holding a lira denominated government bond is the lira that has been promised—if the foreign investors want dollars instead, they have to go and buy those in the market. Turkey’s government is under no obligation to provide the dollars. Similarly, Turkey’s government is under no obligation to provide dollars to firms that have maturing external debts.   Obviously if non-resident investors with maturing lira bonds are buying dollars and firms are buying dollars, the lira could fall significantly—and that has other consequences. But it’s also worth differentiating a bit between the external debt of the banks (the financial sector has over $100 billion coming due according to the central bank's data, with at least $70 billion and probably more in foreign currency—that counts the short-term debt of the state banks together with all claims on the private financial sector) and the government ($5 billion and other financing need). And it is of course possible to do an even finer grained scenario. The banks’ foreign currency debt is composed of a mix of deposits, syndicated loans from international banks, other loans, and a few bonds. The rollover rate in each category will vary. Let’s assume, for the sake of argument, that one third of all maturing external claims rolls off. That would burn through $60 billion in reserves—that could come directly from the roll off of bank claims, or from a decision now to allow a surge in foreign exchange demand from firms (or holds of lira bonds) to feed through entirely into the exchange rate. Turkey and its banks start with $100 billion in foreign exchange—perhaps enough to survive for the year if firms with external debt are left to fend for themselves. But it is close at best. Remember, the lower reserves go, the more likely a broader run becomes. In a run you want to get out and get paid in foreign exchange even if the underlying bank may be solvent because, well, you know the bank will run out of foreign exchange, and it is better to have a dollar in hand than a dollar at a bank that lacks dollars.   So at some point domestic residents would start to run too. A hypothetical $50 billion loan from Russia and Qatar (with $30 billion or so provided up front — Argentina was a $50 billion IMF program with $15 billion upfront, so this is a bit more generous than the IMF's initial Argentine program) would immediately raise foreign exchange reserves at the central bank to around $100 billion (with another $25 billion in the banks). That still leave reserves below maturing short-term external debt, but it would cover the maturing foreign exchange denominated debt of the government and the banks (around $20 billion of total short-term claims on Turkey are clearly denominated in lira).**  It thus provides enough to perhaps manage in a relatively benign state of the world, but falls short of the overwhelming display of financial force that would more or less guarantee success (provided, of course, that Turkey carries out the needed policies—which is no sure thing).  And, well, it isn’t clear that a Russian and Qatari bailout would be all that reassuring to many of Turkey’s current foreign creditors. After all it would signal that Turkey is determined to go at it on its own, and not tap into the biggest potential sources of funds around. And neither Qatar nor Russia have experience providing conditional financing All that means it also would be enormously risky for both Qatar and Russia, financially speaking—   The $50 billion they might provide wouldn’t go through a multilateral institution, so their bilateral rescue would lack the protections that by custom are afforded to the multilateral lenders.  And if it is tried and fails and Erdogan ends up relenting and going to the IMF, the IMF would at a minimum face pressure not to allow its lending to be used to pay Russia and Qatar back. Normal financial logic suggests it isn’t worth it. The financial risks are too high. Russia might face tighter sanctions. And squandering your reserves on a poorly designed financial rescue while cutting pensions has some obvious domestic political risks.    Turkey—an $850 billion economy before the lira’s depreciation, more like a $600 billion economy now—is large relative to the $1.25 to $1.5 trillion GDP of Russia and the $150 billion GDP of Qatar. But it also isn’t clear that today’s world is ruled by normal financial logic.    To be clear: I seriously doubt Russia would try to lead a rescue package on its own. But I wouldn’t be totally surprised if Putin had at least asked his bankers for an assessment of what Turkey might need, and pondered the question. Turkey is a big geopolitical prize. More importantly, it should be fairly obvious that the basic logic for estimating how much Turkey needs also applies should Turkey turn to a combination of the IMF and Europe for support…   * I personally think the IMF’s exceptional access policy decision puts too much weight on fiscal debt and too little on external debt, but, well, that fight was lost several years ago (it wasn't a fair fight, the Fund had all the high cards). ** Here is a chart looking at Turkey's external foreign currency financing need. The central bank's data shows $20 billion or so of short-term claims (on an orginal maturity basis) are in lira. I didn't infer that any of the additional claims in the residual maturity numbers are in lira, so technically this could be a slight over-estimate.

   

Almost all oil-importing emerging economies with current account deficits are under market pressure to adjust ... 

Korea has indicated that it will, very gradually, start to disclose a bit more about its direct activities in the foreign exchange market. The Korean announcement presumably was meant to front-run its currency side agreement with the United States. Optics and all—better to raise your standard of disclosure unilaterally and then lock in your new standard in a trade deal than the reverse. The problem is…Korea’s actual disclosure commitment is underwhelming. If this is all the U.S. is getting out of the side agreement, it is a bad deal. It sets too low a bar globally, and fails to materially increase the amount of information available to assess Korea’s actions in the market. Many emerging markets disclose their purchases and sales (separately) monthly, with a month lag. India for example (see the RBI monthly data here [table 4] and here). That should be the basic standard for any country that wants a top tier trade agreement with the U.S. Remember, the agreement is about disclosure only—it isn’t a binding commitment not intervene. What has Korea agreed to? A lot less. For the next year or so, it will disclose its net intervention semi-annually, with a quarterly lag. That means data on Korea’s purchases next January this won’t be available until the end of September, and January’s purchases will be aggregated with the purchases and sales of the next five months—blurring any signal.* Korea will start to disclose quarterly with a quarter lag at the end of 2019. But that’s still a long lag. Intervention in January 2020 wouldn’t be disclosed until the end of June 2020. Moreover, quarterly disclosure of net purchases doesn’t provide much information beyond what is already disclosed in the balance of payments (BoP). The BoP shows quarterly reserve growth, which combines intervention and interest income, with a quarter lag. Now is it true that quarterly intervention with a quarter lag was the standard in the TPP side agreement. But the Trump Administration has claimed that TPP was a bad deal, and they would do a better deal. They don’t seem to have gotten that out of Korea. And currency intervention should have been a real focus in the negotiations with Korea. There is no doubt Korea intervenes, at times heavily. And I am confident that the absence of any currency discipline in the original KORUS has had a real impact. Korea, in part through intervention, has kept the won weaker than it was prior to the global crisis. And the won’s weakness in turn helped raise Korea’s auto exports, and thus contributed to the increase in the bilateral deficit that followed KORUS. To be sure, Korea’s German style fiscal policy has also contributed to Korea’s overall surplus. But that isn’t something that realistically can be addressed in a trade deal. Moreover, the failure to get a higher standard than TPP undercuts the Trump administration’s argument for bilateral deals. A big, multi-country deal can in theory be held up by a few reluctant countries. Singapore, for example, has made no secret of its opposition to a high standard for the disclosure of foreign exchange intervention (see end note 4 in the currency chapter of the draft TPP agreement; I assume exceptions to quarterly disclosure didn’t arise by accident). Singapore also discloses comparatively little about the activities of the GIC. And a bilateral deal in theory also could address country-specific currency issues—like the activities of Korea’s large government pension fund. A reminder: Korea’s government-run pension fund is building up massive assets, placing a growing share of those assets abroad and reducing its hedge ratio (it is now at zero, or close to it). This at times has looked a bit like stealth intervention. And it certainly has an impact on Korea’s external balance—structural, unhedged outflows of well over a percentage point of Korea’s GDP have helped Korea to maintain a sizeable current account surplus with less overt intervention. And I worry that the pension fund’s balance sheet will in the future provide Korea with an easy way to skirt the new disclosure standard—particularly if Korea would be at risk of disclosing a level of intervention that might raise concerns about manipulation. Suppose the Bank of Korea bought a bit too much foreign exchange in the first two months of a quarter. The Korean government could encourage the pension fund to buy a couple of billion more in foreign assets in the third month of the quarter, and meet that demand through the sale of foreign exchange from the intervention account. Voila, less disclosed intervention. Remember, sales don’t need to be disclosed separately. A bilateral deal in theory could have included commitments disclose the pension service’s foreign assets, and its net foreign currency position vis-à-vis the won (e.g. its hedges, if any). It thus could have set a standard not just for disclosure of direct intervention, but also for disclosure by sovereign wealth and pension funds. The side agreement on currency with Korea consequently looks to be to be a missed opportunity for sensible tightening of disclosure standards, on an issue that really matters for the trade balance.     Now for some super technical points. The intervention data should not precisely match the reserves data. When Korea buys foreign exchange, it sometimes then swaps the foreign exchange with the domestic banks for won. This lowers the net amount of foreign exchange the central bank ends up directly holding, while creating a future obligation to buy back the dollars swapped for won. This shows up in the central bank’s reported forward book. Total intervention thus may exceed the change in reserves in the balance of payments. However, it can be inferred from the combined increase in reserves and forwards—and Korea currently releases both its forwards monthly and its balance of payments data monthly. As a result its intervention can be inferred from these monthly numbers—quarterly data with a quarter lag will add very little. The buildup of government assets abroad—non-reserve government assets that is—now accounts for a significant share of the net outflow associated with Korea’s current account surplus. And with higher oil prices set to lower Korea’s surplus further, that share will grow. As a chart of the net international investment position shows, the rise in the foreign assets by the National Pension Service now accounts for the bulk of the rise in the total foreign assets of the government of Korea. On a flow basis, outflows from insurers are now more important than the pension outflow—however the insurers, unlike the NPS, supposedly hedge. 3. The increased scrutiny of Korea’s management of the won that has come with the negotiation of the currency chapter—and the risk Korea could be named in the foreign exchange report—has had some positive effects. It didn’t keep Korea from intervening pretty massively to block won appreciation in January at around the 1060 mark (and I suspect Korea has bought at a few other times in the first quarter as well). But it does seem to have encouraged the Koreans to take advantage of dollar rallies to sell won and thus hold their net purchases down. In 2015 and 2016 the Koreans didn’t tend to sell dollars unless the won was approaching 1200 (an extremely weak level). In the past few months they have been selling on occasion at around 1100 (or at least not rolling over some maturing swaps and thus delivering dollars to the market). The won’s trading band has been pretty tight. I just think the block at 1060 should disappear.   */ as I understand it, Korea won’t ever disclose its intervention this January—the first disclosed data will be for the second half of 2018.