By Jon Gorvett
Despite its remarkable turnaround in recent years, Turkey’s economy is hugely vulnerable to global turmoil, more so now than at any time in recent years
There are tricky times ahead for Turkey. Crises in the world’s major financial markets look set to spill over to emerging nations as well – hurting even those, such as Turkey, that have been more conscientious in their approach to implementing tight monetary and fiscal policies.
There are signs too that, after bouncing back from the 2001 financial crisis, not all is well with the Turkish economy. In the first half of 2007 annual GDP grew 5.7%, but it has been declining since. The government forecast of 4.5% for 2008 is unlikely, say analysts, who are predicting between 3% and 4%.
“We all knew there would be a slowdown in the second quarter of the year,” says Cem Akyurek, Deutsche Bank’s chief economist for Turkey. “This is a cyclical process, but it has been exaggerated by other shocks.”
For other shocks, read the present global financial turmoil, which is set to spill over from the banking sector to the wider economy. Turkey is particularly vulnerable here: in August the IMF estimated that a one percentage point reduction in growth in industrial countries would slice 0.8 percentage points off Turkey’s own GDP growth.
Falling growth in the eurozone – which accounts for around half of all Turkey’s exports – is feeding into a slowdown in domestic demand. This will then hit these exports and thus the country’s growth.
As part of the same aspect of the financial turmoil, there is a worldwide shortage of credit. Turkey is particularly vulnerable here too, as it has a high amount of external debt, especially in the private sector. “The external net private debt position is over $100 billion,” says Gizem Ozpok Altinsac, an analyst at Garanti Bank. “Financing this will be an increasingly difficult challenge.”
With around 70–75% of GDP coming from the private sector in Turkey, private business has fuelled economic growth for many years. Yet the private sector has also been the leading user of debt, with corporates typically borrowing overseas to finance activities at home.
The reliance on external finance is a logical consequence of high real domestic interest rates, which in turn have been set high to curb inflation. Turkey’s central bank raised the benchmark overnight rate between April and July by 1.5 percentage points to 16.75% – the highest in Europe – where it has since remained. Inflation is running at around 11–12% with a government target of 10.6% for 2008.
Further depreciation in the Turkish lira – it has already fallen 8% since January – will have powerful consequences on corporates’ ability to service their debts. Global financial crises have their corollary in that investors flee emerging markets, so selling and thus weakening the local currency, for safer havens.
Political risk
Political uncertainty refuses to go away. The Justice and Development Party (AKP) was returned to power in the 2007 general election with an increased share of the vote. But its authority was immediately challenged. The AKP was accused by state prosecutors of pursuing an Islamist agenda. The case was only resolved by the Constitutional Court – which chose not to ban the AKP – this July.
Since then political risk has switched to alleged connections between the AKP and a fraudulent charity group called Deniz Feneri (Lighthouse), some of whose executives were convicted in September by a German court for raising funds among Turks in Germany that were then sent to businesses, rather than charities, in Turkey.
Because of possible connections to the AKP, the Turkish public prosecutor asked in late September to see the German case files, ahead of possibly opening a case in Turkey.
Local elections, scheduled for March 2009, dominate the political scene and, unfortunately for good governance, have fiscal implications that could damage Turkey’s relationship with the IMF. “With the local elections ahead,” says Serhat Gurleyem, director of research with Is Bank, “the government may not be in a hurry to take on any tight controls on its activities.”
The government is keen to win control of several cities in the south-east of the country – traditionally won by Kurdish nationalist parties – and is willing to divert public spending to boost its share of the votes.
Public spending for 2009 is budgeted to increase some 11.8%, with an important slice of this going to fund projects in south-east Anatolia. Together with the south-eastern Anatolian project, government investment in the region will rise to the equivalent of $12.5 billion.
Foreign involvement
Some analysts see this as part of the reason the government did not renew its stand-by agreement with the IMF, when the $10 billion accord ran out in May 2008. “I don’t think they are planning on a spending spree,” says Akyurek, “but what they have as their medium-term fiscal plan calls for a primary surplus that may be low for the IMF.”
The government may well seek a new agreement before the elections. Prime minister Recip Tayyip Erdogan recently hinted he might return to negotiations on this in October.
That said, some analysts see such a deal as unnecessary. Turkey has achieved a major recovery since its 2001 crisis, from which the stand-by agreement dates. “Turkey doesn’t need IMF financing,” says Gurleyem, “unless there is a sharp change in the global environment. An endorsement by the IMF is still important, however.”
Since achieving accession status at the end of 2004, Turkey has also benefited from European Union endorsement. As a candidate country, foreign direct investment has soared. In 2004, FDI stood at just $2.9 billion, but more than tripled the following year, doubling again the year after that and by 2007 it stood at $21.9 billion.
In the past, this has helped cover an important slice of the booming current account deficit, which jumped to $31.5 billion in the January–July 2008 period – some 42.5% higher than the same period in 2007.
Long-term capital inflows have accounted for the lion’s share of coverage for this deficit in recent years. These are now heading downwards.
“Long-term credits had covered more than half of the current account deficit in the past,” says Seher Fazlioglu, an economist at Global Securities, an independent brokerage, “but with these decreasing, we expect FDI to cover 25% of the deficit in the future.”
The prospect of EU accession, along with the IMF stand-by, has also meant Turkey entering into a major structural reform process, necessary for it to complete the 32 chapters of regulations in the accession agreement.
Three key areas in this are social security, tax and labour market reform. On the first of these, the government passed a reform act in 2008, while on the last, a package of changes is being prepared. Efforts to strengthen tax collection have also been prioritized by the government.
EU accession, however, appears to be increasingly off the agenda. The more pro-Turkish atmosphere in the EU in 2004 has faded, with several new European governments openly arguing against Turkish membership.
Recognition of the Republic of Cyprus remains a bugbear. Turkey’s failure to expand its customs union with the EU to include Cyprus means that it is unable to close many key accession chapters. New negotiations on finding a solution to the island’s division restarted this year but, as ever, the outcome is uncertain.
Positive Strengths
Yet while there clearly are considerable challenges ahead, Turkey also has a number of important strengths.
First, while GDP growth is slowing, it still outpaces other European countries. Inflation, which only a decade ago sometimes touched triple figures – has fallen close to single digits, thanks to tight monetary and fiscal policies.
“The year ahead will also likely see falling energy prices,” says Fazlioglu, “so we expect to see a decline in real inflation in 2009, as these have made up a large part of price increases in recent years.” Declining energy prices will also reduce the import bill and help the current account deficit, as will a decline in domestic demand.
At the same time, “high interest rates will keep demand for debt and the currency strong,” says Akyurek.
While the international environment may make financing more difficult, intermediaries may still be happy to lend to Turkish corporates in such an environment. Turkey has a strong history of timely debt repayment.
Turkey now possesses a strong banking system, with the crisis of 2001 leading to a major consolidation, the imposition of much stricter regulation and some significant recapitalization. “Turkish banks have even been lending to US ones in recent times,” says Gurleyem. “Structural changes in the economy are behind this. In 2001, Turkish government debt was around 100% of GDP. Now it’s less than 50%. A lot has changed since then, and Turkey is much stronger now.”
The government has announced it plans to make a renewed effort on EU accession, as well as pushing the privatization campaign. Big-ticket items in this programme include two state banks and much of the energy market, along with some highway contracts.
While few expect the banks to be sold off in the current climate, the energy sector may get some new impetus for reform in the year ahead. This involves both privatization of generating and distribution outfits and Turkey’s possible revival of its nuclear power programme.