Turkey’s Walking Dead: Zombie Companies Lurk Around Every Corner


Following Turkey’s failed coup attempt in July 2016, President Recep Tayyip Erdogan imposed a state of emergency, curtailing not only political but also economic freedoms, including a ban on corporate bankruptcies. When the Turkish government lifted the state of emergency two years later, it naturally led to fears of a bankruptcy surge. The Turkish lira’s meltdown in August, contributing to a 40 percent devaluation of the currency this year alone, has exacerbated such fears. Erdogan’s response has been to allow companies to exclude foreign currency losses from bankruptcy calculations, which risks creating a “zombie economy” to complement Turkey’s already lifeless democracy.

Turkey has a well-deserved reputation among lenders for complexity of debt collection, as shortcomings in the justice system have made it difficult for creditors to obtain payment through legal action. Following the 2001 economic crisis, which brought Erdogan’s Justice and Development Party (AKP) to power the following year, the government passed legislation providing non-performing debtors the opportunity to avoid bankruptcy by entering into consensual debt restructuring arrangements. The measure, which helped put insolvent companies and, by extension, the Turkish economy back on track, soon after turned into a loophole, which debtors exploited in bad faith to delay loan payments up to seven years.

In 2014, as Erdogan’s authoritarian rule began to take its toll on the Turkish economy, 720 firms took advantage of suspended bankruptcy provisions to pressure creditors into granting more favorable terms, who in turn pushed back by filing 12,339 lawsuits. Over 1,000 firms applied for bankruptcy suspension in 2015, prompting Erdogan to freeze the loophole, using his state of emergency powers shortly after the abortive coup. Since then, the Turkish president has abolished the practice, encouraging instead composition with creditors, or negotiations with lenders that tend to fast track debt repayment. No longer able to threaten non-payment through the courts for up to seven years, firms began privately negotiating shorter repayment terms at more favorable rates to lenders. The number of Turkish companies asking for composition with creditors in 2018 has already reached 3,000, and is expected to hit 7,000 by the end of the year.

In addition to preventing a wave of bankruptcies post-state of emergency, the measure also sought to prevent a separate wave of defaults from Turkish firms squeezed by the dramatic devaluation of the lira. It is the latter wave that the government hopes to hold off with a new law allowing companies to exclude foreign currency losses from default calculations. This is likely to produce a “zombie economy,” filled with firms that have not technically defaulted on unaffordable interest payments, but also do not have enough cash to continue operations.

Erdogan’s stopgap measures also threaten to exacerbate corporate transparency issues at a time when Turkey is desperately seeking to boost investor confidence. Creditors can look to the case of Turk Telekom, Turkey’s largest telecommunications and technology service provider, as a cautionary tale about the dangers of creative accounting. Turk Telekom, which underwent privatization in 2005 and held its initial public offering in 2008, was once one of the country’s most profitable companies. However, in September 2017, following years of corruption and economic mismanagement allegations, the company was unable to make its very first $290 million payment on a $4.75 billion loan, which had financed Gulf investors’ purchase of a majority stake in the firm.

The news was an embarrassment for Erdogan’s ruling AKP, which played a significant role in the privatization. After Turk Telekom missed its third payment, Turkey’s banking regulator stepped in to ask banks not to re-classify the debt as non-performing, thereby initiating bankruptcy proceedings. The lenders obliged and classified the debt on their books as “closely watched.” When the Turkish government’s attempts to sell the company failed, the creditors had to settle for a 55 percent stake in the company, valued at $1 billion, while the original owners walked away with over $6 billion in dividends collected during their ten-year ownership.

The Turk Telekom case is an example of another worrying trend in the Turkish economy, the reclassification of non-performing loans on banks’ balance sheets. In May, Moody’s predicted non-performing loans would reach 4 percent of gross loans by year-end. Given further lira devaluations, and new creative accounting measures, that number is likely higher and set to increase. That is not the only problem though; new government regulations on how to classify non-performing loans promise to muddy the waters further.

In August, Turkish lenders proposed a new measure, which sought to expedite the restructuring process following a default, and take mounting non-performing loans off banks’ books. Under the new measure, only 75 percent of a firm’s creditors have to agree to a restructuring, which includes changes to capital structure, capital injections, and asset sales. Presumably those lenders who do not agree to a restructuring, favoring a more formal process, such as international creditors, are left out to dry. The government approved the measure.

At the same time, lenders are receiving calls from the government to cut slack for their debtors, resulting in informal and involuntary rollovers and lower interest rates. Yet the non-performing loans continue to pile up. The housing boom, fueled by cheap credit and overzealous government spending, resulted in what economists call the “original sin” for emerging markets. Developers, who borrowed in U.S. dollars but earn their income in Turkish lira, can no longer afford their interest payments following a 40 percent currency devaluation. In the construction sector alone, 90 percent of loans are in foreign currency.

Leaked documents show that the government is now considering setting up a “bad bank,” where Turkish lenders can offload their non-performing loans. However, as one trader noted, “there is no way of avoiding a general decline in Turkey’s overall creditworthiness, no matter where you park the [non-performing loans].” If the government moves forward, it then raises the question: What even defines a loan as non-performing, let alone which non-performing loans should be transferred to a “bad bank?”

Unfortunately, these contradictory measures are indicative of a larger trend in creative accounting, which seeks to mask structural issues in the economy. As the cases of Greece and Brazil show, such shenanigans do not end well — you can postpone a crisis by creating a “zombie economy” that is solvent only on paper, but sooner or later global investors will recognize what’s living and what’s dead.

Once Erdogan’s creative accounting schemes implode, the ensuing contagion from Turkey’s economic meltdown will have dire consequences not only for Ankara, but also for its allies-cum-creditors on both sides of the Atlantic. The European Central Bank has already warned of the exposure of E.U. banks to Turkey, while Merkel has cautioned that a weak Turkey would not be in Germany’s interest, eliciting criticism at home that she has gone soft on Erdogan.

Across the Atlantic, in response to Turkey’s “hostage diplomacy” and continued detention of Pastor Andrew Brunson under dubious charges, U.S. President Donald Trump has chosen to double down on his Turkish counterpart, who accused Washington of waging an “economic war.” Erdogan could now take a U-turn from his unorthodox economic policies and creative accounting tactics while also putting Ankara’s relations with its allies back on track. But, if his recent track record is any indication, the Turkish strongman is likely to go out with a bang, bringing with himself not only his cronies, but also a score of Western investors and creditors.


Aykan Erdemir is a former member of the Turkish parliament and a senior fellow at the Foundation for Defense of Democracies. Follow him on Twitter @aykan_erdemir. John Lechner, a former financial analyst at Lazard and Deutsche Bank, is an intern at the Foundation for Defense of Democracies. He speaks Russian, Turkish, Georgian, and Chechen.

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