Taking a view on the Turkish economy these days is a tough business. Indeed, for yield-hungry but risk-averse investors it can bear a frustrating resemblance to a perennially popular type of visual brain teaser whether the observer sees an unco-ordinated mess or a clear and attractive picture depends on whether the eyes are focused on the short or long distance.
In Turkeys case, it is the nearer term prospect that looks less than appealing. What at one stage appeared to be an encouragingly strong recovery from the global financial crisis has long since turned into a classic case of overheating. Annual GDP growth hit 9.2% in 2010 and slowed by less than one percentage point last year, while October saw the ballooning current account deficit hit 10% of GDP and inflation has been in double-digits for most of the past two years.
Opinion is divided as to who to blame for the situation, with candidates ranging from the Justice and Development Party (AKP) politicians, who arguably allowed fiscal policy to remain too loose in the run-up to last summers parliamentary elections, to the developed world central bankers whose expansionary monetary policy has prompted a flood of liquidity into the more promising emerging markets.
What economists can agree on, however, is that in the short term Turkish policymakers have been left with worryingly little room for manoeuvre in the event of further shocks from beyond the countrys borders. Turkeys $60bn of foreign exchange reserves fall well short of the level required to cover its heavily front-loaded external financing requirements nearly 70% of the $200bn total comes due in the next 12 months.
Furthermore, the central banks fondness for unorthodox policy options has damaged its international credibility. Its reluctance to act to cool domestic demand in the first half of last year was widely criticised particularly since the preferred alternative of raising bank reserve requirements had little observable effect on credit growth.
Similarly, the introduction in October of a dual-policy rate mechanism, whereby the central bank sets separate levels for the overnight and seven-day repo rates and can inject funds at either level, has been seen by many investors as adding an undesirable degree of unpredictability to the market.
But if the immediate outlook for Turkey is mixed at best, refocusing to the longer term produces a very different and much more attractive picture. In terms of macroeconomic fundamentals, it is unmatched among any of its European neighbours, combining favourable demographics in the form of a young and rapidly growing population with public sector debt of just under 40% and falling, and a modest and very manageable budget deficit of around 2%.
Oasis of political stability
It is also an oasis of political stability particularly when seen in the context of both its own history and its fellow Muslim-majority countries in the Middle East and North Africa. Opinion polls suggest that the AKP and its charismatic leader, Recip Tayyip Erdogan, are even more popular today than when they won a third term in government last June with just under 50% of the vote. Even the announcement last month (May) of a revival of plans for a referendum on a new constitution at least partly designed to enable Erdogan to stay in power past 2015 has prompted little unease among Turkey watchers.
"If Erdogan looks to create an executive presidency as part of the constitutional reform programme it could prompt an increase in tension, but AKP has extremely strong underlying support and despite recurrent fears in recent years about heightened political risk it has always won those battles," says Timothy Ash, head of emerging market research at Royal Bank of Scotland.
Indeed, most analysts agree that AKPs dominance constitutes a big part of Turkeys appeal for international investors. "People like to be concerned about Turkish politics but the situation is fairly stable at the moment and its not a big cause for concern," says Gyula Toth, head of EEMEA FI/FX strategy at UniCredit. "Over the long term, people would like to see a stronger opposition but in the short term investors prefer a strong government that has a mandate to do what needs to be done."
Even more encouraging is the way in which politicians have demonstrated both an awareness of Turkeys problems and an understanding of the steps necessary to deal with them. In May, the government moved to address long-held concerns about low savings levels by putting to parliament proposals to expand the countrys second pillar pension scheme from taxpayers only to all citizens over the age of 18.
Other measures to curb the current account deficit and reduce Turkeys dependence on exports include a widening of incentive programmes for investment to include not only manufacturing and other industries but also strategic service sectors such as education, transport and tourism.
In the long term, however, analysts agree that the key to successfully rebalancing the economy will be the reduction of Turkeys heavy reliance on energy imports of the $77bn current account deficit recorded in 2011, nearly three-quarters was energy-related. Here again the government is earning plaudits.
"Oil prices are not under Turkeys control because it is a price taker what is controllable is making Turkey less dependent on imported energy and hydrocarbons, and thats an area of reform that the government has been successfully instituting," says Murat Ulgen, chief economist for CEE and sub-Saharan Africa at HSBC.
The main focus of policymakers attention has been on energy diversification, in the form of promoting the construction of nuclear power stations and, at the end of last year, putting through parliament a law governing the distribution of licences for renewable energy production. Energy conservation programmes are also on the agenda.
Confident banking sector
Also central to Turkeys longer term appeal is its banking sector, which with its clean balance sheets, strong growth and high levels of capitalisation again looks all the more impressive by comparison with those further west. And, while the sector does have considerable exposure to Europe through both foreign ownership and funding flows, analysts are confident that Turkeys banks can easily ride out any further shockwaves emanating from the eurozone.
"Longer term debt flows have historically been quite sticky in Turkey," says Ash at RBS. "Domestic banks have long banking relationships with their Western counterparts and although they have relatively large liabilities theyve always been able to roll them in a crisis."
Similarly, concerns about subsidiaries of troubled Western banks putting the squeeze on local liquidity a real worry in many CEE economies have been soothed by recent research from the Bank for International Settlements (BIS) showing that Turkey is one of only three countries in emerging Europe (along with Poland and the Czech Republic) where European banks have increased their loan book exposure over the past year.
Ash is confident that this trend will continue. "Where possible, foreign banks, if they are going to continue to maintain balance sheets anywhere, will stay in Turkey because it has growth, NPL ratios are relatively low and the policy environment for banks is a lot better than elsewhere in the region," he says.
And even if some European banks are forced to sell up to meet capital requirements back home, there is likely to be no shortage of eager buyers from elsewhere looking to take their place as was demonstrated by Sberbanks announcement earlier this month [June] that it would pay a bare 1.4-1.5 times book value for the most profitable asset of troubled European lender Dexia, DenizBank.
When it comes to export dependency on Europe, Turkey is also one step removed from the eye of the storm. Whereas for most CEE economies trade with the European Union accounts for at least 70%, and in some cases as much as 90%, of total exports, Turkeys trade is much more diversified.
The EU including non-eurozone countries such as the UK accounts for barely half of Turkeys international trade and Turkish exporters are leveraging links with the MENA region to reduce this still further.
Not only has Turkey been cushioned from some of the worst effects of the eurozone crisis but it has even, to some extent, benefited from those it has felt. In recent months the convulsions to the west have caused a much-needed cooling of domestic demand, both through a natural reduction in credit provision and via a mini-currency crisis in December that finally forced the central bank to tighten monetary policy to defend the lira.
From funding the market at an average rate of 5.75%, the central bank has moved to funding in the 10%-10.5% range which in turn has helped bring inflation down by more than two percentage points to 8.3% in May. Economists are tipping it to remain at or below that level for the rest of the year.
Even more valuable has been the effect that the slowdown in Europe and, more importantly, the prospect of one in China and the US has had on oil prices. While Turkeys dependence on external energy is obviously undesirable in the longer term, it does effectively give the country a valuable natural put on the global economy.
At a rough estimate, analysts reckon that every $10 drop in the oil price translates into a $4bn saving for Turkey thus, the $25 drop in oil prices in recent months has chopped as much as $10bn off the current account deficit, which is now expected to come in at around $65bn-$66bn, or around 8% of GDP by year-end. Optimistic estimates even put the year-end figure as low as 7% of GDP.
Soft landing ahead?
Taken in conjunction with the countrys positive long term outlook, this moderating of the key macroeconomic imbalances has convinced Turkey bulls that the country can achieve the soft landing so desired by politicians.
"So far the combination of all the factors, not only monetary policy but strong fundamentals, political stability and focus on structural reforms, are helping Turkey to soft land and our expectation is that this will continue," says Ulgen at HSBC.
Others, however, are more cautious, warning that oil price falls are not the solution to all of Turkeys overheating issues. "The problem for Turkey is that even with a much lower oil price theyre still going to end up with a large structural energy import deficit," says Ash. "There is some rebalancing and the current account is narrowing but it will remain large, and in a very positive story over all for Turkey it is still the Achilles heel."
What is more, he adds, there is a real risk that a cooling economy could prompt demand for a fiscal stimulus along the lines of the consumption tax cuts used to combat the financial crisis in 2009 which, if met, could exacerbate underlying weaknesses.
"If a global slowdown was associated with much lower oil prices and a marked slowing in domestic demand in Turkey, then I can imagine the government feeling comfortable with a looser fiscal policy, but if the current account deficit remains large and they run a very loose fiscal policy that could leave them vulnerable again."
Add to that the scope for rapid monetary easing offered by the central banks flexible interest rate and it is unsurprising that investors remain wary of further overheating although, according to Ulgen, some are starting to acknowledge that the policy may be a valid response to a difficult situation.
"In the past few years weve moved into uncharted territory where global central banks have reduced their interest rates to very low levels and some have been expanding their balance sheets," he says. "The wide interest rate corridor is an unorthodox, unconventional response to an unconventional world."
In the short term, however, investors perception of Turkey is likely to remain mixed, according to Toth at UniCredit. "Some people are really short Turkey because they dont like the current monetary policy and are concerned about the high exposure to a global slowdown on the capital side, while others are staying focused on the longer term story of supportive demographics, potential economic growth and very low public sector debt," he says.
Yet Ash sees signs that the Turkey bulls are starting to outweigh the bears. "Very recently the mood music has improved in terms of risk the current account deficit and inflation have both moderated, the market feels a bit more comfortable with the tightness of policy and overall Turkey is looking a bit more resilient than it did a few months ago."
And as he points out, even before the more positive news of the past few months, Turkey was seeing steady portfolio inflows. Indeed, the currency crisis at the end of last year was seen as a buying opportunity by many external investors.
"When we saw the lira sell-off in December and January it was actually foreigners who were holding faith and locals who were selling, so Turkey is still doing relatively well in terms of attracting portfolio flows," he says. "It shows that theres a level of carry and a level of lira that makes people want to invest in Turkey."
What is more, as Ulgen notes, Turkeys links to its Western neighbours and the wider global economy also offer upside potential and not only in the form of a reduction in oil prices. "Externally there are certainly risks due to Turkeys exposure to the eurozone but there are two sides to this Turkey will benefit hugely if the eurozone comes up with a comprehensive solution to its problems," he says.But whatever the outcome of the next few months, one thing is for sure: as long as investors can see in Turkey, however far in the future, the growth prospects that are so lamentably absent across the rest of Europe, it will hold their attention for a long while yet.