The events of July 15 in Turkey are now well known. Yet while the eyes of the world have focused on president Recep Tayyip Erdogan’s diatribes and defiance since the failed coup, a far larger problem has quietly come into view: the increasingly fragile state of Turkey’s economy. On September 7, the customs and trade minister, Bulent Tufenkci, tipped economic output to expand by between 4% and 4.5% in 2016. To most analysts, that target seems far out of reach. Gross domestic product expanded 3.1% year-on-year in the three months to end-June, according to the official statistics agency Turkstat. Private investments
contracted 1.6% on an annualised basis over the same period, with corporate spending on machinery and equipment down 5.3%, the sharpest drop in two years.
Sales of passenger cars, another key economic indicator, have been on a downward trend since 2011. But they have slumped alarmingly this year, with sales falling 29% and 13% year-on-year in, respectively, July and August. An August 2 note by Capital Economics noted that a “decline in consumer confidence” had caused household spending to “weaken sharply at the start of the third quarter”.
PRE-COUP PAIN
In truth, notes Roxana Hulea, emerging market strategist at Société Générale, an economic slowdown was already happening “long before the coup took place”. She points to the “compound effect of a number of issues” including: economic sanctions imposed by Russia following the downing of a Russian jet over the Turkey-Syria border last November; the stalling of a series of long planned and much needed economic reforms; and a tourism sector battered both by the coup and a series of devastating terror attacks in Ankara and Istanbul.
The loss of momentum in the tourism space is a grievous problem for regions on the Black Sea and Mediterranean coasts. Foreign arrivals fell 36.7% year-on-year in the key month of July, according to figures from the tourism ministry, and by 30.3% through the first seven months. “Given how many dynamics have been working against Turkey in recent years, it’s actually surprising that we didn’t see a slowdown before,” adds Hulea. “But we are probably going to see a significant slowdown in economic growth going into 2017.
This will spell trouble for Turkey and in many ways. Inflation is projected by the International Monetary Fund to come in at 9.8% this year and 8.8% in 2017. The Fund tips economic growth to slow to 3.4% in 2017 from 3.8% this year, one of the factors that will lead to a widening of the current account deficit from 3.6% to 4.1%. The government’s longstanding plan of a steady annualised level of 5% inflation and 5% economic growth seems as far away as ever.
The second concern is the increasingly tenuous grip the sovereign has on its much prized investment grade credit rating. Fitch rates Turkey’s long term foreign currency sovereign debt BBB-, the lowest rung on the investment grade ladder, with a stable outlook.
But on July 18, Moody’s put the country’s Baa3 rating on review for a downgrade. The July putsch might have failed but, the ratings agency warned, the fact that it took place at all reflected “broader political challenges” and left credit risks at “elevated” levels. In a research note published on July 27, SocGen said its base case scenario was for Moody’s to downgrade Turkey’s foreign currency debt by one notch to Ba1 — junk status — within the next 12 months due to waning growth and “institutional deterioration”, an abstract way of aligning the various negative factors that are conspiring to undermine and hamper Turkey’s manifest potential.
Moody’s duly oblliged, cutting its rating from Baa3 to Ba1 onSeptember 23, joining S&P which rates the sovereign BB.
Many of these factors coalesce around the nation’s increasingly repressive president. SocGen analyst Hulea believes the move toward greater autocracy under Erdogan, a process that has accelerated since July, “negatively impacted Turkey’s investment grade rating”.
ERDOLAND
To Guillaume Tresca, senior emerging market strategist at Crédit Agricole, Erdogan “will become even more authoritarian. Every day, he is more and more like [Russian president Vladimir] Putin and he saw the coup as an opportunity to clean the Gülenists out of the system. Turkey is becoming ‘Erdoland’, just as Russia is all about Putin.”
Analysts have also, post-coup, been left wondering whether the global investor community has overestimated the true level of domestic stability. Moody’s on September 5 said the credit profiles of most big non-Turkish firms operating in the country, including consumer goods firms Nestlé, Unilever and Philip Morris International, were likely to remain largely “unaffected by [domestic] political uncertainty”. Yet Crédit Agricole’s Tresca believes investors have simply chosen to ignore the perils that exist in a brittle country low on confidence and which bows to the whims of an increasingly autocratic patriarch.
That could change quickly in the months ahead. In Turkey, the position of president is a ceremonial one, where the cutting of ribbons not the shaping of laws is the order of the day. Erdogan wants to alter that, emasculating the role of the prime minister and transforming his office into a powerful executive presidency in the American — or better yet, the Russian — mould.
Yet that can only happen by rewriting the constitution, which requires the president either to win an up-or-down vote, via a single-issue referendum, or to secure a two-thirds super-majority for his ruling AKP party in the Turkish parliament. Many believe Erdogan is more likely to consider the latter option, leveraging his high popularity ratings in the wake of the coup to declare another general election in the months ahead. “His popularity could give him the parliamentary super-majority he craves,” says Crédit Agricole’s Tresca. “If he calls a poll, it would likely take place in the last two months of the year or early in the first quarter” of 2017.
Erdogan, ever the astute politician, will be aware of the dangers of treading this path. Turkey’s electorate have trudged to the polls twice in the past 14 months; few would embrace a third vote, called merely to increase one man’s control over them.
He will also be aware of the wave of good luck that Turkey has ridden for much of the year. The banking sector remains in robust shape, boasting in the main low levels of non-performing loans and high levels of capital adequacy. “I can’t see a danger on the horizon in that space,” says Credit Agricole’s Tresca. “The only near term threat would be if the government attempted to revive a flagging economy by pressuring banks to lower rates in order to boost credit growth.”
LUCKY TIMING
The Turkish government was also fortunate that, on the night of July 15, the wider populace emerged onto the street to fight those who sought to re-assert the military’s longstanding domestic dominance by toppling the man who had done so much to clip their wings.
The coup also happened at a generally favourable time for emerging markets. Investors in search of cheap equities and high yields have returned in force to higher yielding markets and assets this year. Billions of dollars have been sucked into emerging
market funds, pushing share valuations in the likes of Russia to all-time highs. In Turkey, the Borsa Istanbul 100 index is up 7.5% through the year to September 14, while 10 year sovereign bonds are paying out more than six times their US equivalents.
Had the coup taken place in a less benign time for emerging markets, “the [negative] impact on assets would have been stronger”, notes SocGen’s Hulea. “What helped was that global appetite was quite resilient at that point — plus the way the central bank and other ministries reacted was very positive. There was a lot of good and regular communication between government and investors and analysts.”
Turkey then needs to cross its fingers and hope that investor appetite continues to favour higher yielding markets and assets. “Global investors are complacent about what’s happening in Turkey,” notes SocGen’s Hulea. Adds Crédit Agricole’s Tresca: “In my view, most of the flows draining into emerging markets are by investors who know little about the emerging world. These guys can leave very rapidly if the political risk rises again — if, for example, there are new snap elections or an unofficial rewriting of the constitution. Long term investors such as European corporates could well be put off by rising political uncertainty.”
That, in the end, could be the factor that convinces Turkey’s president not to go through with yet another general election. Instead, he could focus on pushing through the reforms Turkey desperately needs, from boosting productivity and liberalising the state railway system to improving labour market flexibility and deepening the country’s capital markets. “Predicting Erdogan is tricky at the best of times,” says William Jackson, a senior emerging markets economist at London-based Capital Economics. “There is a state of emergency in place which allows him to amend various powers in legislative and administrative branches. Given that, I would wonder if new elections are really necessary at the moment.”