ON A KNIFE EDGE
TURKEY


Turkey is well positioned to weather a global downturn, but it still faces some tough economic challenges.

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Tansan: Ankara must hold out for the best possible terms from the IMF.

There was a time not that long ago when even the slightest suggestion of an emerging market crisis would have investors in Turkey running for the exit and the lira heading south. Yet when the EU finally woke up to the crisis facing Eastern Europe—unveiling the E24 billion bank bailout funded by the European Bank for Reconstruction and Development (EBRD), the World Bank and the European Investment Bank (EIB)—sentiment regarding Turkey remained surprisingly positive.

“The truth is that Turkish banks—with an average loan-to-deposit ratio of 84%—look healthier than those elsewhere in the region,” says Charles Robertson, head of emerging markets at ING Barings. One big reason for this is that Turkey had its big banking crisis back in 2001, prompting wide-ranging systemic reforms and healthy consolidation: The elimination of under-resourced marginal banks reduced the total number from over 80 to around 50 today. A strong regulatory regime, headed by the Banking Regulation and Supervision Agency, successfully upholds risk management and corporate governance standards. The required capital adequacy ratio in Turkey today is 16% against a typical 11% in central-east Europe and 8% in west Europe.

“What you see on balance sheets is what you get: Off-balance-sheet risk is limited, with no derivatives and no subprime loans,” says Burak Tansan, executive vice president at Akbank, Turkey’s largest bank, with a market capitalization of close to $7 billion. Foreign banks have played their cards well, striking a good balance “between local knowledge and foreign expertise,” according to George Chrysaphinis, bank analyst with credit ratings agency Moody’s Investors Service. They have also benefited from the fact that over most of this decade the economy has been growing by at least 5% a year, driven by Turkey’s dynamic private sector, which has in turn provided many opportunities for them.

Storm clouds have been brewing over the wider economy, though. Loans have never been plentiful in this under-leveraged economy—Turkey’s loan-to-GDP ratio is 36%, against around 80% in Romania and Bulgaria—and with risk aversion growing, lending has tightened more than ever. Banks insist that they are continuing to lend, but “we will be more selective in our lending, prioritizing clients we know have a good credit history and a solid business plan,” says Tansan.

There are other signs of slowdown. Although the sale of the national lottery is proceeding, those of the electricity distribution network and two banks have been shelved. Meanwhile, FDI—which between 2005 and 2007 averaged an annual $18 billion before falling to around $11 billion last year—is expected to decline again this year. The government still hopes for between $7 billion and $10 billion, but the Turkish Industrialists’ and Businessmen’s Association (TUSIAD) expects $5 billion at best.

GDP is expected to contract this year by between 1% and 2%. Although growth of 3% has been projected for 2010, recovery will be dependent very much on what happens in the EU. Certain sectors, notably steel and vehicles, which together account for almost 30% of exports, will be particularly badly hit, while construction, which has been buoyed by a large number of infrastructure projects and a housing boom, will also slow.

Diversification Pays Off
Some analysts point out that things should be kept in perspective. “Compared to the bad old days of the 1980s and 1990s, when GDP could contract by 5% to 6% in a bad year, and to Ukraine and Romania, which could see growth fall back by 6% and 4%, respectively, in 2009, Turkey’s prospects don’t look too bad,” says Robertson. He adds that with exports equivalent to just 23% of GDP, compared to almost 80% in countries such as Hungary and Estonia, Turkey is to some extent less exposed to the global downturn.

Turkish business has done much to help itself by developing markets beyond the recession-hit EU. Oxford Analytica, a British research institution, points out that in 2008—for the first time—less than half of total exports went to the EU (with EU imports dropping below 40%), a striking contrast to 1999-2007, when the EU accounted for some 60% of exports. It says Turkey is rapidly diversifying its trade relations, moving from a firm alignment with Europe and building new relationships with the countries of central Asia, Iran and Syria.

The country’s decision to become a full member of the EBRD last October will also bring big benefits. EBRD is undertaking to invest E150 million in 2009 and a further €300 million in 2010, targeting rural areas well away from the Istanbul region, which has historically attracted most investment. Support for SMEs and agribusiness will be a priority, along with assisting with energy efficiency projects and municipal service projects and, more generally, improving Turkey’s attractiveness to FDI.

Fears persist about whether Turkey can hold its own as an appealing destination for investors. Moody’s still rates it as stable, “premised on the authorities’ ability to manage the vulnerability to the global financial market crisis,” and says it could be upgraded if the government generates sufficient tax revenue, continues with reforms—particularly of the labor market and social security—and properly services its debt. However, Moody’s Chrysaphinis admits that “the balance of risks is unfortunately on the downside” amidst a weakening growth outlook, slowing industrial production and capacity utilization.

This largely reflects wider fears, not least about the AKP government, whose accession to power back in 2002, as a single-party government committed to reform and EU membership, did so much to improve Turkey’s economic fortunes. Although investors have not seen a return to the uncertainty engendered by a fractious coalition government, reforms have slowed considerably. So has progress in joining the EU, in part because of hostility from existing members and the still-unresolved Cyprus issue.

Concerns also linger over the party’s Islamist ambitions and the continuing power play between it and Turkey’s secular elite, represented by the army. The lack of a serious, viable and unified opposition to the AKP is also a concern, stoking fears that the party, which also holds the presidency, is becoming too dominant.

All this matters because of Turkey’s dependence on external capital. The non-financial private sector owes foreign creditors some $95 billion and this year alone faces an external financing gap of $30 billion. Most Turks are confident this can be covered. “We will not be paralyzed by this,” says Akbank’s Tansan, although he admits some loans may prove harder to roll over than others.

An IMF deal, probably worth around $25 billion, has already been priced in by markets, which are assuming it will get the green light after the March 29 elections, when the AKP will be better placed politically to swallow any tough conditions imposed by the IMF. However, Tansan echoes the concern of many when he says Ankara must hold out for the right terms. “Countries everywhere are stimulating their economies in the face of the global downturn, and it is vital that any terms we agree to do not prevent us from doing the same,” he says.

Other observers say it is possible that the terms imposed by the IMF could, in the short term, exacerbate the downturn but stress this may be a price worth paying, with the international community appreciating the guarantee of fiscal responsibility an IMF deal brings. “Turkey’s rollover record has been pretty good, but everything is a lot tighter now. Capital flows have declined everywhere, which is why it is so important—especially for the lira—that Ankara secures a new agreement,” says Bob McKee of Independent Strategy, a London-based investment advisory firm.

Once the elections are past and, presumably, the new IMF package agreed, the government, previously untested by an economic downturn, will have to focus on demonstrating it can keep the impact of the global crisis to a minimum. “The authorities need to do a lot more to help business—for example, by extending tax payment holidays and improving the functioning of credit markets so it is easier to access loans,” says Abdullah Akyuz, who heads up Tusiad’s Washington, DC, office.

Turkey will also have to tackle, once again, the thorny issue of EU relations, which in recent months have been on the back burner. The mood regarding negotiations between the Turkish and Greek Cypriots has darkened, with the prospect of a deal now looking less likely than at the start of the year. Early parliamentary elections in the Turkish north of Cyprus in April could bring to power a more nationalist government less amenable to compromise, while the prospect of the south’s elections next year will hang over negotiations in the second half of 2009.

Wolfango Piccoli, Turkish analyst with the Eurasia Group, a US-based think-tank, says lack of progress on Cyprus and continued paralysis in Turkish-EU relations could have serious implications. “Time is running out,” he says. “Although a full suspension of negotiations is unlikely, they could grind to a halt later this year. That would have serious long-term implications for confidence”.



Justin Keay