Features : Testing Times

Country Report / Turkey

International investors barely flinched when Turkey slipped into political turmoil earlier this year. The coming election will be another test of their faith in the country’s stability.




Turkey's prime minister, Recep Tayyip Erdogan

Turkey’s recent economic turnaround has been nothing short of remarkable. During the economic crisis of 2001, it demonstrated few signs of becoming the burgeoning economy that it is today. Back then, according to UniCredit Group, GDP had declined by 7.5%, inflation was nudging the 70% mark, the budget deficit crept above 16%, and public debt was a whopping 108% of GDP. Less than six years later, some lingering concerns remain about inflation and the country’s level of external indebtedness, but thanks to some “hand-holding” by the IMF and the country’s attempt to move toward EU standards, Turkey has created economic stability and increased its attractiveness to foreign investors.

According to figures published by UniCredit in April this year, Turkey’s GDP per capita, which is greater than €4,200, is 80% higher than it was five years ago. Inward investment has grown even more dramatically: From almost “negligible” levels in 2000, Turkey‘s net FDI inflow in 2006 had swollen to $19 billion. In the first quarter alone this year, $8 billion had flooded in, according to leading Turkish bank Akbank. From 2002 to 2006, economic growth averaged 7.3%, and even public debt, which had been a persistent bugbear, declined to 61% of GDP at the end of 2006.

“Since the financial crisis in 2001, the Turkish economy has become stronger and more resilient to shocks through reforms,” says Fatma Melek, chief economist at Akbank. “Financial sector surveillance was strengthened through the Independent Banking Regulatory and Supervisory Agency. During this time, the IMF-supported program was broadly on track, increasing economic predictability and stability.”


Turkish people, one holding a picture of the founder of the Turkish Republic, Mustafa Kemal Ataturk, take to the streets of Istanbul to protest plans to appoint an Islamist as president

Last spring, however, turmoil in the global financial markets took its toll on the local currency. The lira lost approximately 30% of its value in 20 days, and inflation accelerated, prompting the central bank to raise interest rates to 17.5%. Despite this, Edward Parker, head of emerging Europe sovereigns at ratings agency Fitch, says Turkey’s economy is “generally performing well,” with real GDP growth of 6.1% last year—although it is projected to fall to 5% this year. “Already, 2006 was a little problematic, but the growth pattern and FDI was really strong,” says Matteo Ferrazzi, who is in charge of economic research for Turkey at UniCredit Group.

“What I find remarkable about Turkey is the resilience we’ve seen in the financial sector, even with the currency turbulence we saw about a year ago,” remarks Katinka Barysch, senior economist at the Centre for European Reform. That resilience has remained, despite the country facing what some have described as its worst political crisis in a decade, which followed the ruling AK Party’s nomination of foreign minister Abdullah Gul to replace the country’s current president, Ahmet Necdet Sezer. Gul’s association with Islamist beliefs prompted millions of pro-secular demonstrators to take to the streets of Istanbul in protest. His candidacy was eventually blocked in parliament by the opposition Republican People’s Party.

Tensions escalated on April 27 when the Turkish army posted a statement on its website threatening to intervene if “Islamic fanatics” posed a threat to Ataturk’s secular republic. The Turkish military has intervened previously, removing four governments since 1960. Following the military’s statement, which most observers say was unexpected, Turkish prime minister Recep Tayyip Erdogan called for an early general election to be held on July 22, instead of the scheduled November 4.

Economy Shrugs Off Political Tension
In the midst of all this political turmoil, the economy did not skip a beat. Although the local stock market slumped by 8% in early May, it rebounded fairly quickly, and foreign investors did not appear to flinch. As events were still unfolding in the political arena, a foreign consortium offered $1.2 billion for the privatization of the Port of Izmir. Even more remarkable was the fact that, at the height of the political conflict, Turkey’s sixth-largest commercial bank, Halkbank, was sold for $1.8 billion—the country’s largest-ever public offering. “Only 15% of total demand could be met, and 70% of shares were sold to foreign investors,” says Melek of Akbank. “Despite some short-term [political] uncertainties, companies that invest long term see Turkey’s high growth potential and continue to invest.”

Moody’s stated that Turkey’s current political turbulence seemed unlikely to derail the country’s ratings or its ongoing process of economic and political modernization. “We continue to expect that Turkey’s impressive positive turnaround during the past six years will remain largely intact, mitigating the risks posed by the country’s heavy public and external indebtedness,“ said Moody’s vice president Kristin Lindow. Fitch Ratings revised its outlook on Turkey’s foreign currency and local currency issuer default ratings to stable from positive. “Early presidential elections…increased political risk,” stated Parker of Fitch, adding that although its current prudent fiscal policy stance, impressive growth performance, and strong FDI inflows were consistent with improving macroeconomic fundamentals, negative political shocks had raised event risk and clouded the credit outlook.


Shock Waves
Seasoned observers say the crisis—more specifically the army’s intervention—has only provided more ammunition for those EU countries that were already opposed to Turkey’s accession to the EU, and, in the minds of some at least, Turkey’s economic modernization is inextricably linked to its EU accession. According to Moody’s, the military intervening in the political process “is likely to further complicate the EU membership drive,” particularly bearing in mind that the EC suspended eight chapters of the negotiations back in December. Parker says the threat of elevated tensions between the secular establishment and political Islam may persist, which could make EU accession more problematic than ever before.


Ferrazzi: In 2006 economic growth and FDI were really strong


Barysch believes that if the army actively intervenes in Turkish politics, EU accession negotiations would have to stop. “One of the pre-conditions [of the negotiations],” she says, “is to have a well-functioning democracy.” Although the military’s statement was unexpected, Ferrazzi says it was merely an attempt to have some influence on political life, but he thinks a military coup similar to those that occurred in the 1960s and 1970s is unlikely.

Tolga Egemen, executive vice president of Turkey’s GarantiBank, says that if the financial markets thought a coup was in the cards, their reaction would have been more negative. “I don’t think it is important for us to become a full member of the EU,” Egemen continues, saying that Turkey has benefited from the negotiation process itself, which has helped push forward economic reforms and which he anticipates will continue regardless of EU sentiment toward Turkey.

Barysch added that there had been some slippage in economic reforms in the run-up to the early July elections. “The economic reform process has slowed down. We don’t know if that is because it is pre-election or the fact that the reform process is now becoming more difficult,” she says. Egemen says most of the work in terms of reducing the budget deficit and public debt to Maastricht-criteria levels necessary for EU entry has already been achieved.

But in an uncertain political climate, could the progress achieved by the pro-reformist AK Party (AKP) government be unraveled if another party is elected to power? After all, Turkish coalition governments were blamed for the 2001 crisis.

Ferrazzi says re-election of the “pro-EU, pro market and pro-reform” AKP would be good news for the markets but that they must find a president who can forge political unity. “We don’t know whether the ruling AKP will put Gul forward again,” notes Barysch. “If they choose a different candidate, that may be seen as backing down. It is a very tricky issue.” In an effort to avoid future protests from secularists and the military, Prime Minister Erdogan has suggested changing the constitution to let the public choose the president.

Although parliamentary elections will be held on July 22, the current president, Sezer, must approve the change to the constitution to allow the public to vote, and if he vetoes it, it is likely to go to a public referendum, which could push the date out further for the election of a new president. Although the AKP appears confident that it will be restored to power, observers say smaller political parties are merging in an effort to create a secularist block, and many believe there is an increasing likelihood that a coalition government will be elected. “A coalition government may not hurt us as it has in the past,” says Egemen, adding that it could help smooth out the friction between secularists and non-secularists.

If political events do take a turn for the worse over the next few months, some believe there are potential downside risks. “Economic growth was driven by FDI, and foreign investors could get scared by political events in the next few months,” says Ferrazzi. Concerns also remain over inflation, which at 10.7% in April remained stubbornly and significantly higher than the central bank’s end-of-2007 target of 4%. Turkey’s current account deficit also remains a concern, widening to 8% of GDP last year. It is expected to fall slightly this year to 7.2% of GDP. Egemen maintains that most people feel comfortable with the financing of the deficit, as it is half financed by net FDI and IMF money.

If foreign investor sentiment toward Turkey changes in light of future political events, or if there is a global slowdown, the country’s prospects could worsen sharply. “[Turkey’s] external debt ratios are well above its BB-range peers, and its gross external financing needs are the largest of any emerging market in US dollar terms, rendering the economy vulnerable to adverse shifts in global investor sentiment as well as domestic shocks,” says Parker. Turkey is very much reliant on foreign investors continuing to have faith in the potential of its economy.

Anita Hawser



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