Down but far from out. This is the consensus of economists looking at Turkey’s economy following its mini-crisis this summer. “Turkey has suffered a significant shock, but this is far from being a repeat of 2001’s financial crisis. The economy’s overall framework, despite some shortcomings, is robust,” says Serhan Cevik, economist at Morgan Stanley in London. He rather niftily refers to the summer’s events as “an externally driven portfolio reallocation from risky assets by certain groups of investors”.
In what one analyst described as “near-perfect storm conditions”, internal and external factors converged in Turkey this summer to boost inflation, widen the current account deficit and ramp up pressure on the lira. At the same time, the stock market plunged as foreign investors beat a hasty retreat from risky markets.
These events have reminded investors that Turkey remains very vulnerable to external shocks. “With an abundance of global liquidity and a new class of cross-over investor into emerging markets, it is important not to underestimate the importance of liquidity-driven flows into Turkey. To a certain extent the country was a victim of its own success,” says Cevik.
However, Cevik is confident that the combination of macroeconomic and systemic risks that triggered 2001’s crisis will not be repeated, and he is forecasting real GDP of 5.5% for 2006. “Most of these systemic risks have now been addressed. In 2001, the banking sector was effectively a bunch of hedge funds without risk management. That is not the case today.”
Missing the mark
What is clear is that inflation will breach the central bank’s target of 5% this year. Inflationary pressures forced a radical reversal of monetary policy by the central bank, which raised interest rates by 425 basis points between June and August this year, this following about five years of monetary easing.
Ozgur Altug, chief economist at Raymond James Securities in Istanbul, is in line with market views in expecting inflation this year to spill over into double digits, forecasting 10% for 2006, up from 7.7% at the end of 2005. Overall he says that this episode has probably cost the country two years, in terms of inflation targets, with 2006’s initial 5.4% target for inflation now achievable by 2008.
Despite this, the central bank, under the leadership of its new governor Durmus Yilmaz, remains committed to its inflation targeting programme, and one positive outcome of this mini-crisis has been renewed investor confidence in the independence and capabilities of the central bank.
“The past five months have shown that the central bank is prepared to raise rates, at a time when two elections are approaching. This shows that the bank has a strong corporate structure and is doing a good job,” says Altug.
Turkish markets were rocked by a stock market sell-off this summer as asset prices rose in line with the country’s booming economy and investor hopes over EU, and prices looked unsustainable. At the same time, emerging markets investors fled to safer havens amid uncertainty over the direction of US interest rates. The Turkish equity index fell nearly 43% in dollar terms between May 9 when the sell-off started and June 26 when it reached its lowest point. Since then it has recovered nearly 40% in dollar terms.
Corporate bond hopes
Another positive development came when the consumer finance division of Koc Holding, the country’s largest conglomerate, offered for sale the first corporate bond issue in nearly a decade. Metin Ar, CEO of Garanti Securities in Istanbul, says that this could be the first of many: “Assuming that interest rates will continue declining ... we expect new corporate bond issues to continue coming to the market. Increased confidence in the Turkish lira will also play an important role in new issues. Investors will happily welcome local currency bond issuance from strong corporates.”
However, uncertainties remain. Ar says, “Investor attention has now shifted toward local and foreign political developments. Thus, Turkey is likely to experience further weakening in its macro outlook, with higher interest rates and slower economic growth.”
Inflationary pressures in April and May led to strains on the lira. Altug says that this peaked in June, and though the currency has recovered somewhat since, the central bank stands ready to intervene in the FX markets if necessary. One big hole that keeps getting bigger is Turkey’s current account deficit, which has risen by over 50% in the first six months of the year, exceeding $18.7 billion. Altug forecasts that this will end the year at $28 billion.
Oil prices
Although at first sight this appears a truly daunting problem, Cevik says that it is more a function of higher oil prices. He says that if the effects of high commodity prices are stripped out of the equation, the picture improves considerably.
Ar agrees: “It would be incorrect to say that Turkey can fully insulate itself from the changes in global investment environment – no country can do that. This is particularly true for Turkey as it remains a net energy importer. A very large portion of Turkey’s current account deficit stems from energy imports. Excluding them, Turkey’s current account deficit is only a couple of billion dollars.”
For the short term, Altug says that the government has the current account covered. He expects that this year 80% of the deficit will be financed by FDI, and 70% in 2007. Indeed, FDI flows have been strong, and this year Turkey is expected to attract FDI worth $15 billion – a record sum.
Critical to strengthening the country’s domestic economy is improving tax collection. Cevik says that Turkey has the worst taxation structure among OECD countries. “This is a long-term structural problem that must be addressed,” he says.
There will be bumps ahead, but for the long term, economists are confident that Turkey’s fundamentals are solid.