Turkey’s economy came to a dead stop during the first quarter, but the country’s credit bubble continues to grow.

Under the headline “Ankara’s Economic Miracle Collapses,” I argued a year ago in the Middle East Quarterly that Turkey’s economic prowess had more hype than substance. The government of Prime Minister Recep Tayyip Erdogan had financed a consumer bubble with a huge trade deficit financed by short-term interbank loans. The consumer boom is gone, but the credit bubble continues, with bank lending still expanding by 30% a year despite the stalled economy.

Turkey’s current account deficit remains in the red-alert region of nearly 10% of GDP, and it continues to finance the deficit with short-term interbank borrowings. Bubbles like this eventually blow up.

Turkey cannot blame global economic conditions, because emerging market economies are growing at 5.5% this year in the International Monetary Fund’s estimate while Turkey is not growing at all. Turkey’s government debt remains quite low at just 36% of GDP, but private-sector debt – especially short-term foreign debt – has tripled in the past four years.

Most of the US$80 billion in short-term money that Turkey has borrowed since 2010 probably came from the Gulf states, which have a strategic interest in preserving a Sunni power with an army larger than Iran’s. This largesse cannot continue indefinitely, though. Turkey’s central bank promised to reduce its foreign deficit by reducing growth. Now the growth is gone, but not the deficit. The galloping increase in bank debt indicates that Turkish banks are lending their customers just enough to pay the interest on past loans.

This puts Erdogan’s political future in question. His Justice and Development Party (AKP) won the past two national elections on the strength of its economic record. Many Turks are caught in a consumer debt spiral, borrowing to pay a 32% interest rate on credit card obligations. Consumer spending has already started to fall. A few months more of this and Erdogan’s mandate will start to crumble.

The numbers tell the story.

Exhibit 1: Industrial Production YOY Change Falls to Zero

Source: Central Bank of Turkey

Exhibit 2: Real Consumer Spending is Down Year on Year After Inflation

Source: Central Bank of Turkey

Exhibit 3: Turkish Import Volume Is Also Down YOY from a 30% Peak Growth Rate in 2010

Source: Central Bank of Turkey

Turkish import growth has stopped because consumption has stopped.

Exhibit 4: But Credit Card Debt is Rising at a 27% Annual Rate Despite Flat Consumption

Source: Central Bank of Turkey

Since consumer spending is falling, the 27% rate of credit card debt expansion (or 20% after deducting 7% inflation) must reflect Turkish households borrowing to pay the interest on their old debt. The prevailing credit card interest rate is 32%. It’s not just consumers: total bank lending is growing at the same rate, which suggests that businesses are capitalizing interest (borrowing to pay the interest on old debt).

Exhibit 5: Growth Rate of Bank Loans (Quarterly, Annualized)

Source: Central Bank of Turkey

Exhibit 6: Turkey’s Trade Deficit Stabilizes at 9% of GDP – That’s Not Good

Source: Central Bank of Turkey

Even with a stalled economy and zero growth in imports, Turkey’s trade deficit is running at $6 billion a month, or $72 billion a year; that is, 9% of GDP.

During most of 2012, massive Turkish gold exports to Iran – a way of providing the rogue country with the means to flout sanctions – disguised the true size of the problem. As I wrote in this space last December, “Turkey’s gold shipments to Iran are big enough to make a significant dent in the country’s enormous current account deficit. At an annual rate of $17 billion, Turkish gold exports amount to 2.2% of Turkish gross domestic product. Without them, the nominal improvement in the country’s bulging trade deficit (to “only” 7.5% of GDP as opposed to last year’s 10%) would disappear.” (See The talented Mr Erdogan, Asia Times Online, December 4, 2012.)

Since then, the US government has cracked down on this end run and Turkish exports have fallen. Turkey is borrowing in the short-term markets to cover its enormous trade deficit.

Exhibit 7: Turkey External Short-Term Debt 

Source: Central Bank of Turkey

Most of the borrowing comes through Turkish banks, which are taking on short-term loans from other banks. The Bank for International Settlements numbers are shown in Exhibit 8 below. The BIS doesn’t identify the sources of the loans, but Turkish analysts presume that the Gulf states provide most of them.

Exhibit 8: Turkey External Short-Term Interbank Debts and Assets

Source: BIS

Turkey can’t blame global economic conditions. Except for Indonesia, it is the only emerging economy that did not grow during the first quarter of 2013. And it has higher inflation than any emerging economy except for Argentina.

Exhibit 9: Growth and Inflation (1st Quarter 2013), Emerging Economies

Source: Trading Economics

To summarize what the data tell us: even at a dead stop, Turkey’s economy is running a trade deficit of 9% of GDP, and financing the bulk of the deficit on the short-term interbank market. That is unsustainable in the long run, but there is no immediate event likely to trigger a crisis. The Gulf states can continue to keep Turkey afloat for some time. Turkish consumers, though, will have to tighten their belts to manage their debt burden, and the economy is likely to shrink moderately during 2013. Economic troubles will dominate the political agenda, and Erdogan’s claim to leadership of the Islamic world – let alone his own country – will look far less credible.