TURKEY: Looking east
Turkey has so far largely avoided the spill-over from the eurozone crisis. But with no resolution in sight for Europe’s economic woes, what now for the EU candidate?
Only a decade ago Turkey was in the throes of an economic crisis. The Turkish lira had all but collapsed, and the country was forced into a strictly administered bail-out brokered by the IMF.
How times change.
Having swallowed its economic medicine, Turkey is now in the third term of its most popular and stable government since it first embraced democracy in the 1950s. And, more importantly, this is a government that has learnt the lessons of the 2001 collapse.
Although the last IMF standby agreement ended in May 2008, the government of prime minister Tayyip Erdogan continues to implement strict fiscal discipline, with Erdogan himself announcing this May that there was no plan to end strict controls on spending.
More importantly, with its manufacturing-led economy booming these past two years, Turkey has enjoyed the kind of gross domestic product growth most countries can only dream about.
Having sailed through 2008 with little difficulty, the economy averaged growth of 9.2% in 2010 and 8.5% last year.
The biggest problem currently facing the Turkish economy has been caused not by its own economic mismanagement but by that of its neighbours in Europe.
With the eurozone crisis continuing to cast its long shadow over the continent, Turkey has faced its own problem of having to stem inflows of hot money investments looking for higher yield in a world of low interest rates and rein in the countrys expanding current account deficit.
The question now is, could the government manage a soft landing or will Turkey too succumb to the economic recession?
If we look at the recent GDP data, it suggests something a bit harder than a soft landing, says Ozgur Altug, chief economist at BCG Partners in Istanbul. Quarterly GDP has fallen from an annualized 11.9% in the first quarter of 2011 to 3.3% in the same period this year, with figures for the second quarter registering year-on-year growth of 2.9%, slightly lower than expectations.
Altug says that while GDP has slowed drastically there has been no accompanying rise in unemployment, suggesting the hoped-for soft landing has been achieved.
That said, the eurozone crisis continues to cast a shadow over the economy.
Only a decade ago Europe accounted for around 60% of Turkeys exports. However, by the first seven months of 2012 this had fallen to 34.3%, with as much as 15 percentage points of this fall coming since mid- 2011.
Turkeys exports, however, continue to rise by 8.5% year-on-year in July to $12.8 billion, thanks to exporters successfully targeting new markets in the Gulf, Middle East, North Africa and other countries in Africa.
However, analysts attribute a substantial part of the rise to booming sales of gold and precious metals to Iran $1.8 billion in July compared with almost zero a year previously.
The trade, which has surprised many, has apparently been prompted by the imposition in July of new US and EU sanctions against Iran, which have isolated the Iranian financial sector and left Irans businesses and rich alike looking for alternatives.
Although a welcome boost for Turkey while it lasts, it cannot continue indefinitely, meaning the country will need to hope that its core European export markets begin to show signs of recovery sooner rather than later.
Looking ahead its unlikely that gold exports will be a net contributor to the narrowing trade deficit, says Inan Demir, chief economist at Turkeys Finansbank, pointing out that while initial sales to Iran were met from domestic gold stocks, by mid-2012 the bulk of sales were from imported gold.
Gold sales to Iran notwithstanding, Turkeys current account deficit has been a constant cause of concern for markets and rating agencies, with the government struggling to tackle the rising cost of surging imports.
While 2011 saw GDP rise 8.5% to $772 billion, it also saw the current account deficit rise to within a whisker of 10% of GDP, up from 7.5% in 2010.
Peaking at $78.6 billion year-on-year last October, the current account deficit has since been falling steadily, with the monthly deficit reaching $5.71 billion in May 2012 and falling to $4.25 billion in June.
The deficit will continue falling until November, thanks to the base effects, but after that the government will have to take additional measures to ensure that the situation continues to improve, says Ozgur Altug.
In an effort to reduce imports, this April the government introduced incentives to encourage domestic production. However, any benefit is likely to be slow to take effect.
Altug says much of the fall in the current account deficit has come from a combination of the slowdown in economic growth, and the recently stable oil price.
With Turkey dependent on imports for over 90% of its crude oil needs and close on 100% for its natural gas the price of which is linked to the crude price the Turkish economy is particularly susceptible to sudden increases in the oil price.
An extra $10 on the oil price adds $5.5 billion to the import bill. As the oil price rises so does the deficit, Altug says.
More encouraging than Turkeys export performance has been the success of the much criticized so-called unorthodox monetary policies followed for the past two years by Turkeys central bank.
Faced with the problem of hot money inflows, a weakening lira and rising inflation, the central bank opted for an unorthodox policy mix of a variable interest rate corridor and strict controls on the reserve requirement ratios of Turkeys banks.
Although much criticized initially, the policy is now widely held to have been very successful, stemming speculative inflows, stabilizing the lira at around 1.8 to the US dollar and bringing inflation down to marginally above 9% in July. Central bank governor Erdem Basci predicts end of year inflation at between 5.3% and 7.1%. If achieved this will be the lowest inflation rate seen by the majority of Turkeys 75 million population.
Other benefits have followed. Allowing banks to keep as much as 25% of their reserve requirement ratios in gold has encouraged banks to offer attractive terms on a range of gold-based banking products.
In the first half of 2012 Turks banked over 170 tonnes of gold, worth around $6.9 billion. This money is now being put to work in the economy and reducing banks dependence on international loans to fund their own loan portfolios.
The policy looks set to continue, with an estimated Turkish 5,000 tonnes of gold worth $240 billion still held by Turkish households waiting to be tapped.
Turkey, which borders no less than eight states as well as what amounts to a land border with Cyprus, has always been vulnerable to regional tensions, the more so given that it has traditionally relied on its eastern neighbours for supplies of oil and natural gas.
While it has succeeded in diversifying crude purchases away from Iran, Iraq and Syria, Turkey is still dependent on Iran for 20% of its natural gas needs.
Technical problems in Iran and Azerbaijan last winter caused both suppliers to cut off gas flows, causing gas and power shortages in Turkey, and fears are high that with gas demand continuing to grow, any instability involving Iran could result in longer-term gas shortages.
This puts Turkey at serious risk should there be any further deterioration in relations between the West and Iran.
Despite a policy of continued engagement with Tehran over its controversial nuclear programme, Turkish-Iranian relations themselves have been seriously strained by Irans continued support for the Assad regime in Syria.
With Syria apparently heading into a long and bloody civil war, Turkey faces the prospect of the conflict crossing into its predominantly Kurdish south-eastern provinces.
Turkish officials blame an upsurge in violence by the Kurdish separatist Kurdistan Workers party (PKK) on the Assad regime, which recently pulled its forces out of its own Kurdish populated north-east, leaving the door open for groups such as the PKK to launch cross- border attacks into Turkey.
Compared to the situation in Syria, the long-running stalemate with the EU over Cyprus appears less serious, but the discovery last year of major gas reserves in Cypruss economic zone has further racked up tensions with Ankara. Turkey is adamant that any reserves belong pro rata to both sides of the island and is demanding a halt on development until a reunification settlement has been concluded.
Cyprus, with no energy reserves of its own, has instead opened a second licensing round, threatening further confrontation between Turkey and the EU.
With neither side likely to back down, the main hope of a solution appears ironically to be the discovery of sufficient reserves to warrant the construction of an export pipeline to mainland Europe, for which the logical route would be through Turkey.
While gas in Cyprus is bringing Turkey into conflict with the EU, gas in the Caspian Sea promises to bring it closer. Turkey and Azerbaijan this year signed agreements over the construction of a major pipeline to carry Azeri gas to Europe, while ongoing talks with Turkmenistan could mean that its gas reserves the third highest in the world would be made available to European markets through Turkey.
This is good news for the European Union, which has been striving for over a decade to diversify its gas imports away from Russia, which supplies around a third of the continents gas. It is also good news for Turkey, which, as the only alternative route to Russia for transiting Caspian gas to Europe, is set to play a key and likely lucrative role in the continents energy security.