Monday, May 24, 2010

Weekly Hurriyet Column: Giving credit its due credit

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News website since March, you won't see much of a difference between the two. As for cheesy references, I just did a small wordplay in the title this time around.

As for the column, I have an important addendum coming up for the column, but that will have to wait until later, as I need to gather some data and do some reading first.

Anyway, on to the column :

One of the most impressive Turkish economics developments this year has been the rapid loan growth.

Corporate, consumer and housing loans have each registered more than 10 percent rises in the year to date. Annualized, this would translate to a growth of around 50 percent. But before you bring out the party gear, it is important to heed a couple of important disclaimers.

First of all, this growth is following a long period of stagnation in the credit market. Therefore, the strong upward trajectory is likely to slow down in the coming months due to pure cyclical reasons, but there are also structural reasons to expect the rise in credit to lose steam.

For one thing, euro area problems could feed into the Turkish banking sector if they result in a permanent international liquidity squeeze. In fact, with the rollover ratio of external debt at almost 50 percent in the first quarter, Turkish banks were finding it difficult to tap into international liquidity even before the latest meltdown. Continued global risk aversion is likely to make things even worse.

With deposit growth stagnant, things are not looking bright on the domestic front, either. In fact, the banking system has been in a permanent liquidity squeeze for some time. One thing going for credit is the decreasing attractiveness of government bonds, after banking on rate cuts came to an end at the end of last year. Although banks have been slow to load off their bond holdings so far, the process is likely to gain pace, which will contribute to credit growth by freeing up liquidity.

But it is important not to render too much meaning to credit developments in any case because despite common wisdom, credit is not a leading indicator of the real economy. In theoretical economics, credit works its way into the real sector as a financial accelerator: Real economy and financial markets mutually reinforce each other, leading to a feedback loop that amplifies both financial conditions and the macroeconomy. In fact, when you actually run simple causality tests for Turkey, you don't see any effect going from credit to the real sector.

Moreover, the quantity of credit does not tell us much unless we can discern the underlying forces of supply and demand: Loan demand falls during an economic contraction, but banks tend to tighten lending standards as well, which reduces loan supply. It is useful to know which effect is recovering faster, and that’s where the often-overlooked Central Bank’s Loan Tendency Survey comes to aid. While results for the first quarter hint at a recovery in demand as well as supply, the former seems to be generally more pronounced. 

In fact, analysts tend to pay too much attention to the quantity of credit and not enough to its price (lending rates), which is a shame, as price lets us to separate supply and demand effects. Doing that with a simple econometric exercise, I find a pick-up in credit demand in the first quarter. More interestingly, the demand strength is continuing unabated in the second quarter even though credit growth has somewhat slowed down as of late. Therefore, kudos should go to the Treasury for managing to keep debt-rollover ratios low so far and thereby channeling dear liquidity into credit.

Interest rates, when benchmarked, can also give important signals about financial markets. For example, as the Central Bank has noted, the difference between loan and deposit rates shows maturity and default risk as well as liquidity constraints. Lending rates relative to bond rates, on the other hand, is an important factor in banks’ credit supply decision.
Tracking credit is very important, but not for the commonly-assumed reasons. It is important to give credit its due credit.

Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at

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