Growth forecasts in Turkey are falling; the central bank is reconsidering its inflation target in face of the global turmoil; and the current account deficit continues to gape. Nevertheless, Treasury minister Mehmet Simsek remains optimistic. Speaking to Emerging Markets, Simsek pledges to maintain economic stability and launch further reforms. “I am convinced that if we can sustain political stability with an open-minded government, we can generate emerging market growth at a developed market risk,” he says. Not all commentators, however, are as upbeat about the government’s performance and the resilience of the economy.
Global turmoil battered share prices on the Istanbul Stock Exchange in January and combined with political uncertainties [see separate story] to unsettle the lira and halt the decline in interest rates in March. Investor and consumer confidence is low, and GDP growth this year is widely tipped to fall short of the 4.5% recorded in 2007. Meanwhile, soaring inflation linked to high global commodity prices as well as exchange rate weakness is reducing purchasing power and exerting further upward pressure on bond yields.
Counting the capital
At the back of everybody’s mind is the fear that a global liquidity shortage and risk aversion will keep away the large capital inflows needed to finance the perennially high current account deficit. The deficit amounted to $37 billion or 5.8% of GDP last year and is set to grow further in 2008. Against this, inward foreign direct investment (FDI) alone has reached $20–22 billion in each of the last two years, mostly from privatization deals and foreign acquisitions of private companies in banking, telecommunications and other sectors. In the event of a slowdown, the lira could weaken further, compounding the pressure on inflation and interest rates, depressing domestic demand and causing financial difficulties for companies heavily exposed to foreign currency debt.
“There is no question that the magnitude of inflows is going to continue to be a function of global growth expectations and risk perception... You may have a desire to invest, but you need to find funding,” Simsek agrees. But he adds: ”If you look at the M&A pipeline and the privatization pipeline, we already have about $10 billion of FDI year to date from deals done or about to be completed... So $16 billion would be a reasonable guesstimate for 2008.”
Simsek is referring to deals such as the ongoing privatizations of petrochemicals complex Petkim and the former tobacco monopoly Tekel to raise $2.1 billion and $1.7 billion respectively, the $2 billion sale of a controlling stake in private-sector retail chain Migros, and most recently the $2.5 billion share offering for a part of the government’s remaining stake in the dominant fixed-line telephone operator, Turk Telekom. Customers for Turkish assets have come to include public and private institutions from the Gulf as well as multinationals and western equity funds.
Questioned about the lower-than-expected pricing of the Turk Telekom shares, the minister stresses that “Our commitment to privatization is not only about revenues; it’s about promoting competition, enhancing the investment climate and moving towards becoming a more productive innovative society.”
Investment climate
As the sixth largest economy in Europe, with strong tourism, contracting and export industries, an EU accession process under way and “extremely favourable demographics”, Simsek believes that Turkey can attract more and more FDI. “All we have to do is to... enhance the investment climate. We are doing our best... In the World Bank business survey three years ago we ranked 93rd out of 155 countries. This year, the report ranked us 57th out of 178 countries.”
Simsek points out that long-awaited social security legislation, which is expected to make the pension system more sustainable in the long term, was approved by Parliament in April. Legislation has also recently been adopted providing tax relief of up to 90% for companies employing at least 500 full-time R&D staff. In the works are an overhaul of the Commercial Code, a bill on state aids to enhance competitiveness and bring Turkey closer to Europe and a law on Public-Private Partnerships which Simsek says “adopts an even more flexible approach than the UK” to transport, irrigation and other infrastructure. Labour market reform before Parliament this month, the minister argues, “will make Turkish companies more productive, more competitive.”
The minister says that there is “no quick fix” for the current account deficit. But he expects reforms to make a difference. “Energy market reform is critical because our total exports are almost equal to the total current account deficit,” he goes on. Every one-dollar increase in the price of a barrel of oil is reckoned to add $500 million to the import bill. Government policies in the energy sector include rational pricing, diversification of resources, development of hydro- and nuclear power plants by the private sector and privatization of power generation and distribution. “We have a game plan,” the minister concludes. “We are investing in education. We are investing in infrastructure to make Turkey more competitive. There is not much more you can do than that.”
Fiscal adjustment
The government relaxed its key fiscal target for 2008 by some 0.7% of GDP this month in order to pay for reductions in employers’ social security contributions and infrastructure investments in the underdeveloped south-east. Accordingly, the primary fiscal surplus is slated to reach 3.5% of GDP in 2008. This is similar to the below-target outturn of 2007, an election year and much lower than in previous years. The change coincides with the end of a three-year standby accord with the IMF – and hence with Turkey’s exit from more than eight years of almost unbroken IMF tutelage. The primary fiscal surplus target is to be reduced to 3.0% of GDP in 2009, 2.7% in 2010, 2.5% in 2011 and 2.4% in 2012.
Government ministers insist that these surpluses will be sufficient to keep public debt ratios under control. The gross public debt to GDP ratio, which soared during the 2001 financial crisis and recession, has since fallen to 38% thanks to tight fiscal policy, high growth and declining interest costs. “We have satisfied the Maastricht criteria on the ratio of the budget deficit to GDP for the past three years, and we want to keep debt-to-GDP on a downward path,” Simsek says. While he underlines that fiscal discipline also remains important to counter the current account deficit and inflation, he finds it “only natural for Turkey to allocate resources to develop R&D, education and infrastructure as we go along”. The former Merrill Lynch analyst does not rule out a new precautionary standby accord, but it is doubtful whether other cabinet ministers would support this.
Inflation defeat
Monetary policy is also slated for revision after year-on-year consumer price inflation (CPI) hit 9.66% in April, due mostly to high global prices for energy, food and other commodities and the 2007 drought. To make matters worse, the lira temporarily slipped to over 1.30 to the US dollar and 2.10 to the euro in late March and April, compared to about 1.22 and 1.85 respectively at New Year and a mid-January strong point of about 1.14 and 1.70. Partly in response, typical government bond yields rose above 17% in March and above 19% in April. The central bank stopped cutting its key overnight borrowing rate in March and was expected to hike from 15.25% in May.
Acknowledging that rate rises will be no match for imported cost-push inflation, the bank has indicated that the 4% end-year CPI target will not now be met until about 2011. A trajectory for achieving this goal is to be set out later in the year in parallel with the 2009 budget preparations. “They are gaining some time and they hope that by then some of the uncertainties will have cleared up,” comments Fatih Ozatay, director of the Economic Policy Research Institute in Ankara and a former central bank vice-governor. “We won’t be the first country to have changed its target. You can convince people when there are such big external shocks.”
“Missed opportunity”
Ozatay believes that the government missed the opportunity to announce a new 3–5 year structural reform package with a calendar and a new emphasis on micro-issues in 2007, before the global turmoil mounted. “It’s nine months since the general election, and only now are they trying to do something for the labour market. It doesn’t give the impression that it’s part of a new package so it’s far from changing the expectations of the people. At times like this, you have to show your citizens and foreign investors... a story.”
“Due to political polarization, I guess the government couldn’t focus on such a reform package,” Ozatay concludes. He adds that while the labour market reform will reduce the tax burden on employers, it does not comprehensively address labour market flexibility and the quality of human resources. “There won’t be a crisis, but... Turkey will have an average growth rate of 4–5%, which means that the gap between Turkey’s per capita GDP and the EU average will remain intact.”
How much growth?
Minister Simsek accepts that the 5.5% GDP growth rate target will not be met in 2008, but is reluctant to state an alternative figure. Tugrul Belli, adviser to the Board of Turkish Bank in Istanbul, anticipates that GDP will grow by between 3% and 4% this year, and may not recover quickly in future years. He sees parallels between Turkey and Mexico, where the rapid growth that followed entry to NAFTA – two years before Turkey’s customs union with the EU – gave way to growth levels below those prevailing in the US. Low growth would lift the much-disputed official unemployment rate above the 9.9% of 2007, while the workforce participation rate of only 48% could continue to decline.
Despite the risks associated with consumer credit and loans to small businesses, Belli believes that the banking sector is relatively well prepared for the slowdown: balance sheets are strong, short positions are hedged as far as possible and there is no exposure to the instruments which have caused losses in the West. However, he draws attention to the risk taken by non-financial companies which have borrowed heavily from abroad due to high domestic interest rates. The foreign debt of the private non-financial sector was put at $100.5 billion as of the end of 2007, up from $70.9 billion a year earlier and $50.8 billion in 2005. Such borrowing has become a crucial factor, along with FDI, in balancing the current account deficit, but details are scarce. “We have no way of knowing how much will be rolled over,” says Belli.