Selected Capital Markets Options To Promote Long-Term Finance For Türkiye

Turkey needs accessible and affordable long-term finance for moving towards a resilient and sustainable growth path. Several of Turkey’s structural development challenges have their roots in an undiversified financial system that is exposed to short-term and extremely limited local currency financing. The strong fiscal, monetary, and financial sector response to support the economy during COVID-19 created new vulnerabilities, further limiting long-term finance options for Turkey.

Long-term finance—frequently defined as all funding for a time frame exceeding one year—contributes to economic growth and stability in two important ways: by reducing rollover risks for borrowers, thereby lengthening the horizon of investments and improving performance, and by increasing the availability of long-term financial instruments, thereby allowing households and firms to address their lifecycle challenges.

There is significant demand for diversified sources of long-term finance in Turkey. The corporate sector relies largely on short-term bank loans and other short-term liabilities (see chart). Corporate deleveraging was interrupted by the COVID-19 pandemic with corporate debt stock increasing considerably. Access to long-term finance via diversified sources is even more challenging for small and medium enterprises (SMEs).

At the same time, elevated macrofinancial vulnerabilities, including very high inflation and a volatile exchange rate, imply that one of the most important preconditions for the development of domestic sources of long-term finance and capital markets – macroeconomic stability – is not present in Turkey. In its absence, savers and investors will prefer relatively low-risk, short-dated financial products, or choose to invest in real estate, or abroad. Issuers will have to accept high costs with short-dated tenors in domestic issuance or seek long-term investors abroad, incurring in the latter case foreign exchange risk. Turkey’s bank-dominated financial system underdeveloped institutional investor base, and relatively low financial literacy are further structural constraints that limit the development of long-term finance.

Capital markets – often a source of long-term finance – are equally constrained by macrofinancial challenges. High volatility in the local currency government bond yield curve, “dollarization” of the financial system, limited domestic issuance, and the unusually short tenor of debt instruments and high turnover of stocks have been the result. The local corporate bond market has grown steadily but is small and sensitive to external shocks, despite a series of regulatory amendments and policy initiatives. While the equity market saw a significant increase in initial public offerings (IPOs) in 2021, it is unlikely to be a sizable option to address the demand for long-term finance in the near to medium term, especially for SMEs.

Given the constraints imposed by the lack of preconditions, a recent World Bank report analyzed what can be done about developing domestic sources of long-term finance in Turkey. The report argues that while improving the macroeconomic preconditions for long-term finance is of the utmost importance, prioritizing selected debt and equity finance instruments with more potential while addressing challenges in the lack of preconditions could create catalytic effects.

In particular, the report argues that focusing on long-term financing for the green transition may be promising given the strong drive for green and sustainable finance by the private and public sector (including Turkey’s recent move to ratify the Paris Agreement) and the increasing appetite of international investors for such investments. As such, initiatives to promote green and sustainable finance could contribute to long-term finance and capital markets development and mobilize financing for the green transition at the same time.

A stable macrofinancial environment will be needed for all solutions and ultimately, a holistic approach is needed to address capital markets constraints. However, in the short to medium term, the following could be promising opportunities:

Debt financing. Overreliance on bank lending shows the significant potential for corporate bonds for financial diversification and longer tenures. While developing domestic savings and the investor base is critical and will require long-term efforts, tapping funding from international investors, especially those for thematic green and sustainable investing, could give a push to long-term finance in the short to medium term. Turkey has already witnessed overseas issuance of green and sustainable debt instruments but is yet to develop its local sustainable bond market (including green bonds and green sukuks). A unified taxonomy across the financial sector would reassure thematic debt investors on the genuine green or sustainable credentials of a particular issuance. The recently issued Guidelines on Green Debt Instruments by the Capital Markets Board (CMB) of Turkey is a welcome step forward. As part of the development of these guidelines, a CMB–World Bank Group “Green Finance Workshop” was held in June 2021 with a broad set of stakeholders.

Equity financing. High leverage and reliance on short-term debt financing highlight the importance of equity finance via private equity (PE), especially for SMEs, given that raising equity in the public markets via IPOs is challenging for SMEs.  The PE market has achieved a certain level of sophistication but remains undersized (except for venture capital [VC]), with a significant drop in activity in recent years due to macro turmoil. Promoting domestic PE investment could be useful to address SME finance challenges and help greening firms and promote green technologies amid transition risks stemming from the EU Green Deal and geopolitical pressures.

The success of any solution and initiative relies heavily on improving key preconditions and implementation capacity. A stable macroenvironment, given the need to attract foreign capital, is critical. Improving such preconditions will take decisive, long-term efforts. Fundamental improvements of capital markets segments should go hand-in-hand with demonstration initiatives that may have potential, despite the lack of important preconditions. Design and implementation rely on capacity and governance that may require further improvement.

While assisting Turkey in sailing through economic turmoil and improving macro-financial preconditions, the World Bank is looking forward to engaging with the Turkish authorities and the private sector on developing diversified sources of long-term finance, lowering high corporate leverage, and accelerating financing for the green transition and sustainable recovery.