What a difference a year makes: only 12 months ago Turkey was a model of political and economic stability. The government of Prime Minister Recep Tayyip Erdogan was looking comfortably settled into its third term in sole majority control. The Turkish economy, having sailed largely unscathed through the eurozone crisis affecting its western neighbours thanks to a healthy degree of fiscal prudence was, if not booming then at least looking comfortable. It was recording consistently among the highest growth rates in the OECD, and was comfortably placed to take advantage of the tentative upturn in Europe which promised a dividend for Turkey’s export-geared manufacturing industries.
Equally positively, Turkey’s longest-running domestic political issue – that of the country’s sizeable Kurdish minority – appeared to be close to resolution, with a new government initiative involving talks with the outlawed Kurdish Workers party (PKK).
There were, of course, some clouds on the horizon. The current account deficit continued to cast a shadow, but there was hope that falling oil prices would help to keep it in check. There was also the smouldering civil war in Syria, but it appeared to be heading towards an opposition victory, without spilling over the border into Turkey.
As of June, though, that hopeful picture has taken a sharp knock. What began as a simple protest by a few environmentalists over the destruction of a public park in central Istanbul spiralled uncontrollably into countrywide protests, fanned by incompetent policing and uncompromisingly aggressive rhetoric from the government. While the protests eventually subsided, Turkey’s image as a pro-western democratic role model for the emerging democracies of the Middle East and as a safe holiday destination had taken a severe knock, and so had confidence in the government to manage the economy effectively.
“Investors have been reminded that political stability could be in jeopardy sometimes in Turkey,” BGC Partners said in a written note, adding that it is likely that investors will continue to attach a political risk premium to Turkey.
Worse was to come of fears of an international war in Syria further affecting tourism revenues and pushing up oil prices, both of which in turn would hit Turkey’s current account deficit. But all this paled into insignificance with the announcement in May by the Federal Reserve that it was planning to taper its monthly bond-buying programme. Although subsequently rescinded or postponed, the decision sparked immediate fears that Turkey, which is heavily dependent on foreign portfolio inflows to cover its current account deficit, would suffer particularly negatively.
This, coupled with fears over Syria and Turkey’s own stability, saw the lira drop 13% to over 2.07 to the US dollar, and the Istanbul stock exchange (BIST) suffer a similarly sharp fall. While the BIST quickly recovered its losses, the markets were not convinced by central bank assurances of a recovery in the lira, which, having risen to 1.96 to the dollar, subsequently slid back again under 2 mid-September.
Although by late September central bank governor Erdem Basci was still offering assurances that the lira would return to 1.92 to the dollar by year’s end and 1.8 in 2014 if capital inflows improved, the three-month roller coaster ride saw the bank forced to sell over $9 billion of its $50 billion foreign exchange reserves, raising questions about whether it could afford to resist another attack.
LOW DEBT
Few are faulting the government on fiscal probity after 10 years in power, with Fitch awarding Turkey its first investment-grade rating in November 2012, followed by a second from Moody’s in May this year. Turkey has also scored further successes by reducing the current account deficit from 10% of gross domestic product to somewhere over 6% over the past two years. However, further reductions towards the 4–5% level that the government accepts is necessary have proved more difficult to achieve.
Over the first seven months of this year, the current account gap hit $42 billion, of which only $6.8 billion is financed by foreign direct investment. With its own capital market still undeveloped, Turkey has to rely on inflows of foreign capital to finance the rest of the deficit, leaving it dangerously exposed to changes in Fed policy. According to Fitch Ratings, “dependence on net capital inflows is one of the key risks to the Turkish economy.”
Any significant tapering of bond purchases and that liquidity could all but dry up, a risk the government is aware of. Finance minister Mehmet Simsek says that the Fed tapering is “a major risk for emerging markets” but that it is already partly priced in. “While it is hard to make predictions, we think that the Fed’s stimulus tapering is likely to happen gradually, reducing the risk of a sudden stop,” he tells Emerging Markets in an interview. To face potential shocks, Turkey will further strengthen its fiscal position to maintain investor confidence, the public debt ratio will be kept “on a downward trend”, and the country will continue with structural reforms to ensure high growth rates, Simsek adds.
Analysts warn that international change is in the air. “We are potentially looking at a global environment where financing conditions will be tighter,” says Inan Demir, economist at Finansbank. Reducing the current account deficit remains a priority, as does a continued commitment to the structural reforms necessary to attract more capital, in particular long-term FDI as opposed to portfolio flows, also called “hot” money.
Unfortunately for Turkey, it’s not just capital inflows that remain largely beyond its control: with few energy reserves of its own, Turkey is also dangerously exposed to fluctuations in the global oil price, which also fixes the price of the imported gas used to generate almost half the country’s electricity. Speaking in September with the lira at 2.0 to the dollar and oil at $103/bbl, energy minister Taner Yildiz pointed out that an exchange rate of 1.8 to the dollar and oil at $100/bbl would save Turkey $7 billion on its annual energy bill.
Simsek points out that last year Turkey’s energy import bill was $60 billion, and its current account deficit was around $48 billion. “In other words, Turkey would have posted a current account surplus of nearly $13 billion, 2% of GDP,” if it hadn’t been for the price of oil, he says. Simsek estimates that a $10 per barrel rise in the price of oil increases his country’s current account gap by around $4.7 billion. “As a large commodity importer, falling commodity prices would help improve Turkey’s external balance and the outlook for both growth and inflation,” he adds.
SHORT-TERM CONCERNS
Of no less concern is Turkey’s short-term debt stock. “At around $350 billion, Turkey’s total external debt is less than 50% of GDP and not high by international standards, but most of it is short term, and this adds to the current account deficit,” says Demir. “I don’t see any problem rolling over the debt; my concern is that there will be a lack of financing for the growth rates Turkey would like.”
Rolling over is not likely to be a problem even though $165 billion is due in the next 12 months. Of that, $140 billion is private-sector debt, much of it accounted for by foreign trade credits to Turkish corporations, syndicated credit to Turkish banks, forex accounts held in Turkish banks and overseas subsidiaries of banks and corporations.
As Turkey’s banks have a capital adequacy ratio of over 16% – more than double the 8% required by Basel II – they have no problem rolling over their debt. Similarly corporate debt is not viewed as a major issue. A major crisis may put some companies in trouble, but the economy as a whole is not under threat.
What all this means for the Turkish economy in the coming year is, though, still unclear. While analysts concur that Turkey will continue to grow at a far faster pace than most of its European neighbours, just how fast and under what conditions is uncertain. “There has to be a balance between wanting growth and ensuring the economy doesn’t suffer a hard landing because of the external financing requirement,” explains Tim Ash, head of emerging markets research ex-Africa at Standard Bank, pointing out that the Turkish lira is highly unlikely to return to the levels of 1.8 to the dollar which it enjoyed at the start of the summer. “We’ve had some adjustment already, and probably there is more to come,” he cautions.
Also it is now certain that GDP growth for the year will be considerably lower than the 5.5% being predicted at the start of the year. First half growth was only 3.7%, and despite the seasonal boost from second half agricultural production, the full year figure is still not expected to top the 4% target. “To get growth of 4%, they will need to decide what interest rates they want to run, what exchange rate and what inflation rate is acceptable,” says Ash, pointing out that in the wake of the unusual political rhetoric since the protests in June, the central bank has been less than clear in its policy direction.
Indeed, many analysts point out that since the government chose to blame the summer protests on the previously unknown “interest rate lobby”, the bank has shown a marked reluctance to adjust its rates upwards even when conditions demanded. Such unusual politicking, though, is nothing new in Turkey, says Ash. “People accept that Turkey is in a difficult neighbourhood and there are elections coming up,” he says, pointing to Syria and to the coming Turkish election cycle which will see local and national elections and also the country’s first direct presidential election, held in the next year to 18 months.
Ironically, that election cycle, which is expected to cause a further degree of political instability, could also serve to boost the economy. “Thanks to the low public debt ratio and the low fiscal deficit, the government has room to use fiscal policy to support growth,” says Demir, suggesting the possibility that the government may choose to give the economy a boost ahead of the polls.
Whether the election cycle will boost the chances of the long-mooted settlement for Turkey’s Kurdish minority is still also unclear, with some sides suggesting a pre-election deal could boost Prime Minister Erdogan’s standing and others cautioning that a deal is still a distant prospect. What is clear, though, is the value such a solution could have for the economy. “The resolution of the Kurdish issue is perhaps the most important issue in terms of making Turkey a really investable country, and would most certainly be a long-term positive,” Demir says.
— Additional reporting by Antonia Oprita