China Debt Dynamics: Part 2, Measuring the Burden

Rapid accumulation of debt in China is nothing new: between 2000 and 2013 the stock of bank debt rose at a compound annual average of 15.7%.  And on the face of it, that rate hasn't changed much – as of February 2014, bank lending was growing 14.2% yoy.  And that accumulation of debt has, of course, also financed dramatic economic growth: in nominal terms, GDP grew at 14.7% on a CAGR during the same period. So the question arises, what's changed? Is China's debt problem significantly worse than it used to be, and if so, what impact is it likely to have?

The purpose of this piece is simply to provide metrics which may be useful in thinking about the changing role debt finance is playing in China. It is worth, perhaps, anticipating my conclusion: the credit splurge of 2008 really did change China's financial structure, and for the worse.  The debt burden China's economy is currently carrying is dramatically more challenging than it used to be, and is certainly enough to impair current growth prospects. Moreover, as we shall see, it also means that the financial reform which China's central authorities are undertaking is absolutely necessary.  But at the same time, it poses a challenge to that reform, since the current levels of debt mean any significant rise in interest rates – which one would expect under interest-rate liberalization –  is likely be sharply punitive for those sectors encumbered with debt.

But – and this is crucial – China's cashflows as a whole remain positive, so, barring policy or political accidents,  a credit meltdown is unlikely any time soon. And that's the problem: my reading of China's shifting debt position is uncomfortable because although it clearly points to the need for change, it does not make it inevitable. China's economy can struggle on for some time under current policy-settings: that's the problem.

The fact that China's nominal GDP has grown at 14.7% CAGR this century whilst bank lending has grown at 15.7% immediately tells us that the build-up of debt/GDP has been less steep than is commonly assumed. On 2013 bank debt/GDP stood at 122%, not dramatically higher than the 116.4% of ten years earlier. China's problem lies not so much in the stock of debt per se, but rather in the falling economic efficiency of debt. One way of measuring this is to look at the amount of extra nominal GDP associated with a extra debt. One can contrast the pre and post 2009 credit-splurge periods. In 2004-2008 (the five years before the credit splurge), every 1 yuan in extra bank debt coincided with an extra 1.28 yuan in nominal GDP: in 2009-2013 (the five years after the credit splurge), evey 1 yuan in extra bank debt yields only 0.68 yuan in extra nominal GDP.  The marginal efficiency of bank lending as it related to GDP growth effectively halved.

This is the beginning of an argument not its end – one can and should question why it happened, and even whether it was a necessary adjustment. This piece is not that argument, it merely seeks to demonstrate that the economic role and impact of credit in the last five years is not the same as it was in the previous five years.

Does this declining efficiency of credit matter and if so, why? It matters because it allows us to start putting numbers on the economic burden of China's debt stock. In particular, it allows us to estimate how the financial cost of stimulating an economy by extra debt has risen. If one multiplies the average debt-stock by the average lending rate, one finds the proportion of GDP which must be committed to paying debt interest. One can then use the economic efficiency of marginal debt to calculate how much extra debt as a % of GDP would be needed to earn that amount. What this captures is the escalating effect of relying on ever greater inputs of ever-less-efficient credit in order simply to pay debt interest.

And this is where the problem really shows up: not in the rate of growth of credit per se, or in the rise in the debt/GDP ratio, but rather in the combination of these with the falling efficiency of credit. In 2004-2008 the fact that a yuan of extra credit would seemingly produce a more than an extra yuan of GDP meant that even though nominal interest rates were higher, the economic burden of servicing that debt was not increasing: taking on more credit simply made economic sense. In the 2009-2013 world, however, that has changed, with the economic burden of servicing debt more than doubling, and it making no economic sense to borrow more in order to generate the income to service that debt. 

But bank credit is no longer China's only source of finance: aggregate financing (including the 'shadow banking' which so scares commentators) has also been rising rapidly, at a CAGR of 18.7% over the last decade.  The story of declining efficiency and consequently sharply rising economic burden of the stock of financing is essentially the same as for bank credit, only in every aspect worse. I estimate the stock of aggregate financing stood at 140% of GDP in 2003 and 198% of GDP in 2013. Repeating the same calculations, the economic efficiency of aggregate financing fell from 0.8 in 2004-2008 to 0.37 in 2009-2013, and the amount of new aggregate financing needed notionally to service interest payments on the rising stock rose from 11.3% of GDP in 2004-2008 to 30.9% in 2009-2013. 

The deterioration seems extreme. So it's worth remembering three things:

1. China's private sector is still producing a sharp savings surplus, equivalent to 5.2% of GDP in 2013, I estimate. This represents (and is) the net flow of cash from the private sector into China's banks. Whilst these positive cashflows exist, systemic risks to China's banks will remain speculative.
2. Excess credit itself is likely to erode the marginal efficiency of credit, and conversely, new credit discipline can be expected to improve the efficiency of credit – and this effect can be dramatic if asset turns are forced higher.  So these numbers are less predicting an outcome than projecting a trend. And we know how well that sort of thing normally turns out. 
3. A sensible and informed China analyst will want to ask serious questions about why the efficiency of finance fell so sharply over the last five years, and will almost certainly not be fobbed off with the answer 'look at all those ghost cities.' At some stage, there are legitimate and important questions to be raised and answered about China's capital deepening. 

Nevertheless, I think the numbers do establish two things: first, the role credit plays in China's growth is fundamentally different after the 2009 credit splurge than before it; second, the scope for repeating the post-2009 credit-splurge is  limited, since  any repeat is likely to be much less effective economically and leave a much worse hangover.  China's leaders have put reform centre-stage for the next seven years, and one of the central planks of that reform is financial reform. You can see why.  

US Machinery Sales - When Seasonal Adjustments Fail

Today's news that wholesale sales fell a shocking 1.9% mom sa, with key machinery sales down 0.2% mom should be treated with some caution, because it's possible that the seasonal adjustment process is doing quite as much damage to the data as the weather, or the underlying wrinkles in the US capex cycle.

One of the least conspicuous victims of the great financial crisis has been the quality of Western economic data, or, to be absolutely specific, the reliability of seasonally adjusted economic data in the US and Europe.  Seasonal adjustment mechanisms are all predicated on the usually-correct assumption that most types of economic activity are distributed unequally throughout time – more people work in the day, more people go shopping at Christmas, and more financial analyst roadshows take place in October-November than any other time of year.  So seasonally adjustments work by looking back over the past few years to work out the usual patterns, and then deflate accordingly.

Most of the time this works well enough, but sometimes events can be so unexpected and so violent that they displace the normal pattern of activity.  For example, Japan's 2011 earthquake/tsunami/meltdown disasters over-rode normality; and so too did the great financial crisis of 2008/09. These dramatic disasters throw huge rocks into the pool of economic activity, and the way seasonal adjustments are calculated mean they are pretty much guaranteed to ripple throughout the next few years.

But there's one check you can make: seasonal adjustment should merely redistribute activity around the months of the calendar year, it should never significantly add or subtract to the totals accrued for the year in question. When there's a significant difference between the annual total (or growth) of seasonally adjusted data, vs non-seasonally adjusted data, you know for certain something's wrong.

When it comes to wholesalers' machinery sales, things started to go wrong in 2011, when the seasonally adjusted dollar total came in 1.8% lower than the non-adjusted total. In 2012, things got worse, with the seasonally adjusted total coming 2.9% lower than the non-adjusted total. Although things improved considerably in 2013, the impact of the errors was still showing in the yoy comparisons, with seasonally adjusted sales claiming a rise of 12.3% in 2013, when the non-adjusted count actually came to only 9.3%.

(At a total wholesalers sales levels, there was no similarly large discrepancy – the wholesale trade as a whole evidently didn't take such an asymetric hit as the demand for capital goods.)

These errors will diminish with time, and eventually pass out of the system, and 2014 may be the year in which the seasonally adjusted data finally reconciles with the unadjusted data. But for the time being, it's worth understanding that  there's another way of reading today's wholesalers data:

1. Wholesale sales rose 3.6% yoy, on a monthly movt which was 0.3SDs above historic seasonal trends
2. Wholesale sales of machinery rose 11.6% yoy on a monthly movt which was 0.8SDs above historic seasonal trends. 

As the chart below shows, stripped of its seasonal adjustment, January's wholesalers' machinery sales show not significant slowdown.

Corporate Japan's Persistent Comfortable Defensive Crouch

Japan's Ministry of Finance's quarterly monster survey of private sector balance sheets gives us the most detailed breakdown of corporate Japan's behaviour that there is. If Abenomics really is to have the power to fundamentally change expectations, and so change private sector economic and financial behaviour, it's here that it'll show most unequivocally.

There was so much to like about the 4Q survey that it takes a moment to appreciate why there's no substantial pick-up in capital expenditure – capex rose just 4% yoy in 4Q, which was significantly weaker than expected.  Ironically, to a large extent it is Japan Inc's strengths that bar the way to any early rejuvenation of Japanese industry.

For the details show us just how corporate Japan is doing what it does best: securing margins, and using the cashflow to pay down debts even at a time when topline growth is insufficient to allow a rise in asset turns.  What this playbook emphatically does not include is any sudden rise in capital stock, or any one-off rise in workers' compensation.  The message from corporate Japan, rather, is this: topline growth will have to be seen and sustained before the working practices learned in such a hard school since 1990 are revised.

First, consider the good news: sales grew 3.8% yoy (though fell 0.5% on a 12ma basis), but operating profits jumped 28.5% yoy and 16.1% on a 12ma.  Return on assets rose to 4% annualized, which was the best quarter since 1Q08, and the 12ma of 3.55% was the best since 3Q08. Similarly, ROE rose to 11% annualized, the best since 2Q08, and the 12ma of 9.8% was the best since 3Q08.

What's driving those profits are operating margins, which rose to 4.09% in 4Q, the best since 1Q07, with the 12ma rising to 3.76%, the best since 3Q07. OP margins rose 0.5pps qoq, with the gain being generated almost equally by a 0.2pp fall in cost of goods sold/sales and a 0.3pp fall in SG&A. Better still, the fall in SG&A/sales comes from ex-labour expenses, ie, falling management and admin costs.

But the usual suspects continue to offset the gains made by expanding margins. Financial leverage (total assets/equity) rose to 2.77x in 4Q, leaving the 12m unchanged at the record low of 2.77x. Net debt/equity ratio fell to 59.3% in 4Q from 60.4% in 3Q – another new low.  And although 4Q asset turns (sales/total assets) rose to 0.97, this was best since 1Q12 only, and the 12ma of 0.943 was unchanged, again at a record low.

And that's the problem right there – asset turns are not yet improving, and until they do, there is little ROE incentive to add capacity. In fact, cashflow for calendar 2013 was down 25% yoy, even though 4Q was a sharp and positive reversal from the cashflow drain of 4Q2012.   For the year, cashflow was only 3.2% of sales, which is not impressive for Japan – the long relationship is 3.9% of sales.   That, and the fact that asset turns are still at historic lows, helps explain why capex is so low – up just 4% yoy, which means, for calendar 2013, investment is only just enough to cover the depreciation claimed!  What we have, is stasis still, not expansion.

There is a second problem too: the good margins work is not yet being passed on to the staff. In fact, the number employed fell 2.9% yoy in 4Q. In addition, and compensation per employee fell 0.5% yoy in 4Q whilst sales per employee rose 2.3% yoy.  Sales as a multiple of employee expenses consequently rose, to 7.77x, the highest since 4Q10. The problem is that on a 12m basis, that ratio is the highest only since 1Q13! In other words, as far as Japanese management is concerned, what's going on is simply a recouping of the margins previously sacrificed to labour in the immediate aftermath of the disasters of 2011. And there's no reason to believe the process is complete, or to expect an outbreak of corporate largesse.

China Debt Dynamics: Part 1 - Government Debt

This is Part 1 of a two-part series. This piece was originally carried in the Shocks & Surprises Global Weekly Summary for week ending 3rd January 2014. 

Holiday seasons are generally a convenient time to slip out bad news, and so it happened that China published its latest and best effort to tally government debts on New Year's Eve 2013. A serious effort this was as well, with 54.4k auditors deployed to ferret out the liabilities of five levels of government – central, provincial, prefectural, county and township administrations are all counted. The total as of June 2013 came to 30.27tr yuan, equivalent to a not-so worrying 56% of GDP, but also to a distinctly worrying 248% of total govt revenues (tax and non-tax) for the 12m to June 2013.

Even the maximalist 30.27tr yuan tally comes to only 56% of GDP, which by itself is hardly an alarming proportion. Despite the headlines, this number is not directly comparable to the previously announced 10.7tr yuan estimate of local govt debt as of end-2010 – that tally accounted for only for provincial, prefectural and county govt debt. Even though the debt total is sharply higher than previously thought, this is still not debt-meltdown data. But it ought to alert us to the way this larger-than-expected debt total is likely to bear on policy-choices and policy-making.

The key weakness, and therefore potentially a key policy-constraint, is that the debt is large relative to China's ability to raise taxes: 30.27tr is equivalent to 248% of total central and local revenues, including both tax and non-tax revenues.  That means that every one percentage point rise in financing costs has the potential of attracting (over time) a rise in interest payments equivalent to 2.5% of total revenues.   Now, in the 12m to September 2013, China's fiscal deficit of 811mn yuan was equivalent to 6.5 percent of total revenues. In other words, whether China likes it or not, current fiscal policies are now significantly leveraged to financing costs.

The obvious conclusion from this is that PBOC probably faces more constraints on raising interest rates than previously thought.  And from that, we should also expect that 2013's experience of allowing a rising Rmb to exert increasing economic discipline is likely to be extended in 2014 and beyond. The strong Rmb may be painful for exporters, but their interests are unlikely to outweigh those of the government.

The second obvious conclusion is that China is going to need to raise its government revenues relative to GDP. In the 12m to September, revenues were equivalent to 22.6% of GDP. This proportion has been largely unchanged since 2011, and has interrupted the steady progress made in raising this ratio since 1998 at least (when it was just 11.7% of GDP).  Evidently, for the last few years, the tactical need to support the economy over-rode the strategic need to raise the tax-take.  At some point, that strategic issue will have to be addressed.

The renegotiation of tax raising powers and responsibilities between the Centre and the Provincial governments outlined in the 3rd Plenum were always going to be one of the tougher reforms to deliver. These numbers make those negotiations tougher – a lot tougher – as well as more urgent. Quite possibly this is the single biggest and toughest reform upon which the rest of the package will stand or fall. [So far this year (as of early March) it has not featured significantly as a topic of discussion.]

And there is a third thought: if the debt-total highlights the government's unexpected sensitivity to rising financing costs, then it also raises the classic Chinese question:  who pays?  In this case, it's not difficult to imagine that sections of the financial industry – banks in particular – will find themselves picking up some of the costs involved in keeping the apparent financing costs down, even if market rates rise.  The temptation to extend financial repression – ie, by keeping deposit rates negligible  - even in the face of liberalizing lending interest rates is likely to be strong.  Similarly, we can imagine that the Ministry of Finance is rather more attached to those 20% deposit reserve ratios than previously thought – commandeering deposits is, after all, the cheapest source of financing of all.

And there is this final thought: although it may seem that New Year’s Eve is a suspiciously quiet time to slip out such important data,  the fact that is was published at all is important. It is a message from China’s leadership of the seriousness of their intentions, and the limits of their room for manoeuvre.

Northeast Asia Exports: China’s New Year Caveats, Japan’s J-Curve in the Wings

Let’s start with a serious caveat: the way Chinese New Year wanders around the calendar makes it dangerous to read too much into China’s economic data during the first two to three months of every year. Trade data, retail data, inflation, money - all are affected - and even after decades of trying, I’m still uncertain how to which numbers will be affected, and in what way.

This year, it ought to be relatively simple: Chinese New Year fell on January 31st,  whilst in 2013 it fell on February 10th.  So generally, we ought to expect January to have had fewer working days this year relative to 2013 and consequently figures for industrial output and exports to be relatively depressed in January before rebounding in February.

But quite possibly it won’t work out like that. The  nearest similar timing would be in 2009 (when Chinese New Year fell on Jan 26th, vs Feb 07 in the previous year): in January 2009, China’s exports were down 0.4SDs from trend in January before collapsing 1.9SDs in February.   But one can counter that with what happened in 2003 (Feb 1st 2003 vs FEb 12th 2002), when January’s exports were 2.3SDs stronger than expected, before giving back 0.8SDs in February.

So perhaps China’s Ministry of Commerce spokesman was telling nothing but the truth, when he was quoted yesterday as warning the 1Q exports will be 'volatile'  and 'we can't rule out the possibility that February’s trade figures will show an abnormal change from last year.'  And ‘we should be clear that [January’s] export surge doesn't necessarily indicate favourable times for Chinese exporters’, even if the outlook for the year as a whole is ‘cautiously optimistic’.

And whilst we’re reading the runes, the willingness to let the Rmb depreciate over the last week is also compatible with nervousness about February’s export numbers.

Nevetheless, January’s export data was strong not just for China, but for Japan and Northeast Asia as a whole in a way which defies the popular belief that Asian economies are slowing, and which essentially has not been recognized. In dollar terms, NE Asia’s exports rose 4.7% yoy in January against 2013’s toughest base of comparison (exports jumped 15.5% yoy in Jan 2013).

In momentum terms, January’s movement was 1.6SDs above historic seasonal trends.  As the chart below shows, this was merely an acceleration of a trend of rising momentum that had been quietly building throughout 4Q13. In fact, on a 6m basis, the underlying momentum in January reached its highest point for three years.  Whilst consensus seems resigned to another year of single-digit  export growth from NE Asia in 2014 (following 2.5% in 2013, 3.1% in 2012), even if the unnoticed outperformance of the last six months dies right now, Northeast Asian exports are likely to grow in the high 'teens in 2014.  I suspect this is not yet on anyone's radar.

Although China inevitably bulks large over this data, since China accounts for nearly 59% of NE Asia’s exports, it is not the only contributor.  In Japan, too (still about 19% of NE Asia exports), January was strong, with exports up 9.5% yoy in yen terms, which beat historic seasonal trends by 0.4SDs. The statistical impact of yen devaluation is beginning to slide out of the data: the yen was down 14.7% yoy against the dollar in Jan vs 19.2% yoy in December. Consequently, the fact that in dollar terms exports fell 6.6% yoy disguised an outperformance vs seasonal trends of 0.6SDs, allowing the 6m momentum trendline to break into substantially positive territory for the first time since May 2012.


The chart below measures 6m changes in export momentum for China, Japan, S Korea and Taiwan, both in local currency terms, and also in volume terms. By January, each economy was showing positive and accelerating momentum, led by China and Japan. 

Finally, there is one other piece of surprising news - Japan’s trade numbers may finally be beginning to benefit from the J-curve impact of the depreciation in the yen. The J-curve’s arrival has been delayed so long we’ve stopped expecting it. And on the face of it, the record Y2.79tr trade deficit in January is just another demonstration of its absence. However, there are two reasons to see beyond that. First, January’s trade balance was principally the victim of a 37.7% yoy collapse in ship exports - the classic ‘lumpy item’ distortion.

Second, the fall of Japan’s share of NE Asia’s exports is now finally slowing. As the chart below shows, the peak of Japan losing market share came in August 2013, when over the previous 12 months it had slipped by 3.2pps to 19.5%. By January, that market share loss had slowed to 2.5pp, with a market share of 18.7%. It's not dramatic – indeed, it still hasn't broken the surface. But it is there: the J-curve is in the wings.

Foreign Investors and the US Taper

The news that in December foreign investors sold a net US$45.88bn of US securities capped a year in which, unprecedentedly, the world repatriated capital from the US.  Although it may not seem immediately obvious, there are circumstances in which this might matter a lot to the US in 2014 and beyond.

The capital outflow came to US$133bn during 2013, and it contrasts with the US$613bn net capital inflow into the US in 2012 – so it's a turnaround in financial behaviour of approximately US$746bn in a single year. What's more, the fact that the US saw a net capital repatriation by its foreign investors is something that has happened only once before in post-Cold War financial history, as the chart shows. Even at the depth of the financial crisis of 2008/09 capital still flowed into the US. Not now.

This seems like a genuinely historic change in behaviour. Changes in financial behaviour tend to be extremely rare – a once in a generation reconsideration of tactics and strategies. If it proves so, it will influence the underlying flows of capital and trade for years and possibly decades to come.

All of which makes it remarkable that it has had no noticeable impact on the US: money supply, bond yields, dollar value, net foreign liability position of the US banking system – none seem to have been challenged by this abrupt reversal of international capital flows. If it is a historic change, it is one which has arrived seemingly without consequence.

The reason, of course, is the link between the Fed's buying (and guidance) and net foreign investment. On the one hand, the Fed has simply been prepared to buy all the bonds foreign investors wanted to sell.  Whilst foreign investors sold US$133bn of securities in 2013, the Fed bought no fewer than US$1.08tr. The chart below shows the way in which Fed buying has tended to offset net foreign buying over the last few years. 

But of course the relationship between the Fed and foreign investors has another strand: like other investors, foreign investors spent much of 2013 anticipating the onset of the Fed’s tapering. Net selling started in February, but then peaked in the 3m to June with US$115bn of net selling, as markets absorbed April’s FOMC news that tapering was probably on its way.  So the Fed’s forward guidance might be said to have both encouraged foreign capital out of US treasury markets at the same time as buying the securities they wanted to sell. 

Even so, such net foreign selling should be expected to erode the positive monetary stimulus of the Fed’s treasuries buying.  And indeed it has: the Fed initiated QE3 in September 2012, and the Fed’s balance sheet shows its holdings of securities rising $51.1bn only in 2012, but $1.0844tr in 2013.  But once you adjust this for the reversal of foreign capital flows, the net buying changes only from US$664bn in 2012 to US$951.2bn in 2013.  As the chart shows, the net effect has been . . . . moderate. 

What matters for now is whether the foreign net outflow of 2013 was purely a trading response to the realization that the taper was on its way, or whether it represents a fundamental shift in global financial behaviour.

If the former, then we can conclude that the exit of foreign capital essentially initiated a de facto tapering some nine months earlier than officially executed. More, it raises the possibility that the visible negative impact of the Fed’s actual tapering this year may itself now be positively offset by a return of foreign capital inflows, or at least a cessation of the outflow.   

Since December, the Fed has announced a cut in its monthly bond buying from the original US$85bn per month to US$65bn. This tightening of US$20bn a month would be halved simply by a cessation of net capital outflows (which averaged US$11bn a month in 2013).

If, by contrast, the willingness to repatriate capital from US securities markets represents a once-in-a-generation re-ordering of financial risks and rewards, then the Fed’s taper could be a gamble which turns out to be unexpectedly painful.

In short, the monthly net long-term capital flows announcements from the US now demand watching closely.

Finally, we need to look at the other side of the transaction:  US$133bn is a sizeable amount of capital repatriation. It would be enough to form a powerful offset to the view that news of Fed tapering has stripped easy capital from emerging markets and helped precipitate a range of currency crises. But alas, the main selling has come not from Asia, but from Europe.  In December, for example, when total net selling came to US$45.9bn, European investors sold US$48.8bn, whilst Asian investors bought a net US$7.1bn, with China’s net US$5.36bn selling offset by net buying from Japan of US$6.73bn.

Turkey - The J-Curve Can't Come Soon Enough

Turkey’s current account deficit to US$8.32bn, the worst since March 2011, tells us that Turkey’s cashflows continued to deteriorate sharply in 4Q, with no sign yet of the sort of turnaround which would justify any relaxation of the pressures on the Lira.  December’s current account deficit featured not only a $2.67bn widening of the trade deficit, but also a $767mn rise in gross international income payments and a $1bn narrowing of the services surplus.

Eventually, of course, we should see the devaluation of the Lira produce a J-curve upswing in trade flows, but for December, exports rose only 4.5% yoy, on a monthly movement which was 1SD below seasonal historic trends, whilst imports rose 16.7% yoy, which was 0.1SDs above historic trends.

In fact, private sector liquidity trends are probably slightly worse than the current account deficit trends suggest, since the total savings/investment balance is actually being improved by 4Q fiscal restraint in Turkey.  In every month in 4Q, the government’s total domestic debt actually fell slightly, in all by L4.939bn, which in theory should have moderated the decline in the current account deficit.  So the Turkey’s private sector savings position was in deficit to the tune of L36.9bn in 4Q, equivalent to an estimated 9.4% of 4Q GDP, and taking the 2013 private sector savings deficit to 6.9% of GDP.  This deficit expanded throughout 2013, and compares to 4.9% in 2012.

The private sector savings deficit is, of course, a key measure of the cashflow position between Turkey’s private sector and its financial system: in this case, we can see that somehow the financial system must either generate enough cashflow to keep the private sector’s activities unchanged – by selling government bonds or by taking on foreign liabilities – or alternatively the private sector’s activities need to change in order to curb its net demand for cash. 

The balance sheet of Turkey's banks shows clearly enough how the private savings deficit has been financed. In the year to Dec, banks' loan books grew 32.9% yoy, or by and amount equivalent to approximately 14.4% of GDP,  but also equivalent to about 170% of estimated nominal GDP growth in 2013. The stock of bank debt at end-2013 was approximately 58.2% of GDP, up from 47.9% at end-2012. December's figures, incidentally, show no sign of any slowdown in lending momentum.   Meanwhile, deposits grew only 21.7% yoy in 2013, so the loan/deposit ratio was pushed up to 103.1% by end-2013.

Turkey's banks financed this in the way one would expect: net foreign liabilities of Turkey's banks grew by US$22bn in 2013, almost doubling to US$5.58bn.   At the same time, the amount of securities held for sale fell 1.4% yoy, and their total securities book grew only 3.4% yoy. 

With Turkey’s central bank raising its overnight lending rate to 12% from 7.75% at the end of January, it is now clear that the private sector’s economic and financial behaviour is expected to make the adjustment. The fact that it has a net cashflow deficit of approximately 6.9% of GDP tells us this will be painful. So that J-curve improvement in trade and current account balances cannot come soon enough. 

But there is a kicker which the rest of Europe is likely to feel. With Turkey's banks willing to fund private sector savings & cashflow deficits, it is no surprise that investment spending continued to surge throughout 2013, with national accounts showing capital formation spending rising 9.6% yoy during the first nine months of  2013. By my estimate (formed by depreciating all gross fixed capital formation over 10yrs), Turkey's capital stock is currently growing around 11.7%. Topline growth has not kept up with this pace, so asset turns, and probably return on capital,  have declined uninterruptedly since mid-2011. 

But what happens now is precisely that this capital spending will stop, and Turkey's industries will raise asset turns and cashflow precisely by satisfying export demand, at no matter what price. The rest of Europe must expect that as Turkey seeks to deploy that capital stock more intensely, its industries will be eating someone else's lunch – almost certainly those of its near neighbours in the Eurozone.