Bilateral Relations Background – theses

 

  • ▲ Turkey relies on Russia for critical energy supplies, i.e. its demand is relatively inelastic until it resolves its over dependence on Russian oil and gas. This is likely to happen in the next 5-10 years
  • ▲ Russia imports from Turkey foods and manufactured goods—clothing, machinery and equipment. Its demand is very elastic.  Turkey’s tourist sector is dependent on Russian tourists.
  • ▲ Bilateral trade has fluctuated at USD20-38bn but trade deficits of around USD15bn persisted for Turkey.
  • ▲ Factors that will continue to exacerbate the deficit: (i) Grand projects such as nuclear power plant; (ii) weak economy in Russia that impedes import demand including from Turkey, (iii) security concerns and possibly renewed political tensions reducing Russian tourist inflow.
  • ▲ Overall Turkey cannot reduce its dependence overnight while Russia has options
  • ▲ Both TRY and RUB are prone to depreciate but in different ways. TRY is weakened by pro-inflation policies and political risk; RUB is affected by political risk, domestic economic policy flops, but mostly by commodity / energy prices and slow growth
  • ▲ TRY/RUB exchange rate has been super volatile and since 2014 has been trading in the 15-29 range (17.5 today)

 

Overall, Turkey’s position is more disadvantageous in the short run but its superior economic and population growth, and diversified economy can give it an upper hand over the long run.

 

Reasons to switch bilateral trade to national currencies

 

▲ Economic: avoid the mediation of a third party currency that each trading counterpart must have. Reduce exchange costs – to and from reserve currency

 

▲ Hybrid economic + political: reduce dependency on third party that controls the reserve currency, including for monitoring the flows and clearing

 

▲ Political: use it in propaganda that we are building a multipolar world without the US diktat

 

Overall all three fit Putin’s agenda and to some extent Erdogan’s.

 

The economic problems of Turkey and Russia become ever more visible as the countries are facing turbulent times and tough decisions. Most of the issues are of structural nature, some are associated with the volatility of the RUB and the TRY, but they all could be traced back to the policies of President Erdogan and President Putin.

 

One of the latest innovations has been the idea of both Turkish and Russian presidents to replace USD in bilateral trade with China and Iran. The idea fits well with President Putin’s grand design to overhaul the global system towards greater multi-polarity, denying the US the status of the sole global military, financial, economic and political superpower.

 

Russia and China have consistently tried to cut their dependence on the USD and decisions taken by the US government and the Federal Reserve against a negative background of mounting US sovereign debt now exceeding $ 20 trillion. They are not alone in believing that while governments need to balance cross border payment and trade flows, forced to adopt severe austerity measures to balance budgets, the US government fails to join this mainstream relying on the printing press and the world trade’s dependence on the USD as the base reserve currency.

 

Replacing the USD and the EUR dominated multilateral with bilateral trade in national currencies has been long considered a must for countries that contemplate policies that could be at odds with the West and henceforth seek to limit vulnerability and damage in the event of confrontation and sanctions from the US and the EU.

 

The thrust to a national currency based trade is another key indicator of what both the Turkish and Russian Presidents see as their future policies vis-à-vis the West.

 

The technical side of the use of national non-convertible currencies in bilateral trade is sufficiently covered. However, it is easier said than done as goods’ and services’ price levels are difficult to measure and fix in contractual arrangements, while using historically volatile currencies.

 

Suffice to compare the volumes of trade and financial flows on both sides to understand where deficits or surpluses are likely to occur, which might then lead to business agents buying extra reserve currency to settle payments.

 

Trade between Russia and Turkey features significant imbalances, asymmetric elasticity and the trends are not too comforting for Turkey, at least in the short run. According to an article published in the Al-Monitor newspaper and devoted to bilateral relations after a peak in 2008 of $ 37.8 billion dollars bilateral trade fluctuated, in spite of Turkey refusing to join the EU/US sanctions after Russia’s annexation of Crimea. Particularly alarming are the last two years, as 2016 is likely to mark record low levels – less than 20 billion dollars.

 

Turkish imports from Russia remain relatively inelastic due to high dependence on Russian energy imports (more than 60% for natural gas). For the foreseeable future Russia may count with some certainty that its main export items are secure, including the mega project of NPP Akkuyu (over $ 25 billion).

 

Turkey lacks reciprocal security as its exports to Russia are mostly foods and manufactured goods, henceforth it has no certainty that its exports would be in a position to generate approximately equal financial flows from Russia.  Even if Russia wants to help Turkish imports, a weak economy may reduce domestic demand for them.

 

Insofar as the Turkish NPP is of the “build, own, operate and transfer” type, the deficits in the balance of payment will be spread over the next 20 years, which will alleviate one time stress effects.

 

For the first half of 2016 trade turnover has fallen to $ 8.5 billion, of which only $ 0.7 billion Turkish exports to Russia with the rest Turkey in need to pay for the energy resources imports. The main reason is the Russian embargo, after the shooting down of the Russian plane. However, the second reason is of a more persistent nature – the economic downturn in Russia and the shrinking demand for Turkish imports.

 

The substantial drop in the number of Russian tourists to Turkey shrunk financial proceeds to Turkish hotel operators and retail traders, with the peak levels – reaching $ 5 billion now a distant memory. Despite projections for a warm up in bilateral relations leading to an increase in Russian tourists, continuing drop in Russian domestic purchasing power will inevitably spell doom to expectations that tourism would be a position to balance payment deficits in bilateral trade.

 

Repatriation of profits from Turkish companies operating in Russia need to be accounted for in the overall picture of bilateral payment balances. In 2015 alone Turkish companies signed new contracts worth over $ 4.3 billion. The whole Putin period since 2000 has brought an impressive $ 64 billion in contracts to Turkish companies operating in Russia. It is questionable whether and how financial flows generated in development, construction and other projects in Russia will affect the net worth of trade between the two countries as substantial part of the transactions require payments in rubles  to local entities, i.e do not involve cross border financial flows.

 

Other things being equal, payments in national currencies are nominally made possible via agreements between central banks, guaranteeing that all entities carrying out payments for goods or services will receive the equivalent in the national currency at end of the term (the year) with adequate settlement mechanism – Turkish traders receive Turkish liras for their Russian rubles , Gazprom and other energy companies get Russian rubles for the Turkish lira.

 

But appearances of easiness often mislead, notably when comparison is drawn between Turkish attempt to trade in national currencies with China, on one hand, and with Russia, on the other.

 

What is feasible for trade with China is hardly an option for trade in RUB and TRY between Russia and Turkey.

 

Trade with China in national currencies does not involve particular risk for Turkey because the Chinese yuan is stable – from 2012 to the present day fluctuations are in the range – 6.4 to 6.95 yuan per dollar, the country has the world’s second largest economy, the world’s largest foreign exchange reserves (more than $ 3 trillion), strong and diversified export structure, which ensures that the yuans one owns can be translated back into other foreign exchange.

 

Accordingly trade surpluses originating in greater sales of Chinese goods and services in Turkey should lead to more Chinese FDI or greater purchases of the importing country’s goods and services.

 

Last year the yuan was adopted as the third reserve currency of the IMF when calculating the unit of account – the basket of Special Drawing Rights (SDR) and though still it does not have the full fledged status of a convertible and global reserve currency, largely because of the insistence of the Chinese leadership to have the final say when controlling the exchange rate, the lack of convertibility is not an issue.

 

The question of receiving payments and holding large portfolios of Russian rubles implies a greater currency risk and potential losses, although currency risk hedging is possible. The Russian ruble reflects not only the state of the Russian economy, but mostly the turbulence in the global market of energy resources – the price of crude oil and natural gas in the first place. After the crisis in Syria and tensions with NATO and the EU, Russia was able to increase its exports of weapons to almost $ 17 billion annually, but it is still afar from the revenues generated from oil and gas.

 

As a currency pair, the ruble – lira one, has been quite unpredictable and volatile.  Both currencies are set to depreciate, only for the different reasons and at different time scales.  The Russian ruble, mainly due to the rise in the price of crude oil managed to stabilize from 72 rubles to the dollar in early 2016 to around 61 rubles at the end of the year, i.e. rose by nearly 15% . During the same period the Turkish lira registered a decline of 19%.

 

Since 2014 the Lira was trading in a wide range of 15 to 29 to the Ruble.  This illustrates the currency risk and lack of predictability in the commercial transactions with national currencies between Russia and Turkey.  Hedging that risk is of course possible via currency swaps that may be constructed on central bank level as well as between private counterparties.  In the situation when one country runs consistent deficits however the entire trade flow cannot be hedged by definition.  The trade-deficient party would simply run out of other party’s currency to deliver on its side of the swap.  Such hedging would inevitably contribute to financial costs at the expense of the competitiveness of goods and services.

 

The volatility of the currency pair has a deeper reason – both Russia and Turkey are countries with a high country risk and higher spreads of risk premiums that reflect identical economic and financial problems – flight of capital, the collapse of FDI and a dangerously high “political” risk due to authoritarian regimes.

 

In theory authoritarian rulers can order national traders and central banks to start accepting payments in partners’ national currencies, but this will be neither their first nor their natural choice. It will be a notably drastic shock for Gazprom and Russian oil companies instead of dollars to start receiving the equivalent in Turkish liras. Moreover, that the Russian energy giant is publicly listed and it would be difficult to convince shareholders that the revenues are denominated in weakening or volatile currency. The currency depreciation risk will have to be agreed further with additional transaction and hedging costs coming along and dividends suffer.

 

This type of geopolitical deals that deny market gravity are well beyond the kill of authoritarian presidents like Putin and Erdogan.

 

While in political terms trading in national currencies for Turkey and Russia makes sense – the economic and financial merits are in serious questions.

By Ilian Vassilev

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