Author: Justin Keay

Financial markets may initially have reacted well to the reelection of the AKP and prime minister Recep Tayyip Erdoğan, but his success belies deep-seated political and economic problems.

During normal times, Turkish municipal elections would generate little excitement, except from commentators desperately studying the results in an attempt to gauge the national mood. However, these are not normal times.

In the days leading up to the March 30 elections, Turkish newspapers, radio and TV seemingly followed the candidates’ every move, with both sides warning of violence and political assassinations. The mood was especially tense in Ankara, where Melih Gökçek, the candidate of the ruling Justice and Development Party (AKP), faced off against Mansur Yavas for the Republican People’s Party; the AKP candidate won by a whisker. Asli Aydintașbaș, a columnist from the leading Turkish daily newspaper, Milliyet, summed up the polarized national mood. “We are at an important crossroads,” he argued.“What is at stake is fundamental rights and freedoms, and democracy.”

It wasn’t just the media scrutinizing the vote. Markets—already jittery because of the global downturn in confidence in emerging markets and concern at Turkey’s specific economic and financial problems—were keeping a nervous eye on the lira and current-account deficit. 

Ironically, the vote did little to ease matters. Sustained by its core support, the ruling party performed rather better than expected, nationally polling around 45%—well above the 40% bar that would have suggested the wave of corruption scandals had eaten into its core support, and above the 38.8% won in the last local elections in 2009. In his victory address, Turkish prime minister Recep Tayyip Erdoğan declared his opponents would “pay the price.” Observers said there was little doubt what this would mean. “Erdoğan will go on the attack, and this, I fear, will increase the tensions and sense of polarization,” says Larry Brainard, managing director and chief economist of Trusted Sources, a consultancy focused on emerging markets economies.


The market consensus now is that the appetite for much-needed and overdue reforms—of the business environment, privatization process, the pension system and education, to name just four—will be weak. 

“After the local elections we have the first-ever direct presidential elections in the summer, then next year the all-important parliamentary ones: The outlook for the reform agenda doesn’t look too good whilst Turkey’s riding this roller coaster,” says William Jackson, emerging markets economist at London-based consultancy Capital Economics.

The serious news is how personalized the political debate has become, and the extent to which everything is now seen to revolve around prime minister Erdoğan. One leading international business newspaper suggested the 11 years of growth and progress presided over by the AKP ruling party is now imperilled, arguing: “Turkey must look beyond Erdoğan: Premier can no longer return country to moderate path.” Meanwhile the highly influential US journal Foreign Affairs warned that Turkey needed not only to overcome its reliance on “fickle foreign funding (but also) the intrusion of heavy-handed politics into its economic life.”

Others highlighted that the local elections showed that Turkey is polarized between AKP supporters—generally the poor and the pious, with a base in the Islamist Green heartland in central Anatolia—and progressive, secular Turks who resent AKP control.

“Turkey right now is suffering from a dangerous mix of a tense political situation and big external vulnerabilities,” 

          ~ William Jackson, Capital Economics

 The source of the bitterness remains the continuing struggle between Erdoğan and his former mentor/ally, US-based cleric Fethullah Gülen. With Erdoğan’s opponents accusing him, his family and close associates of corruption and the prime minister reacting with fury at “fabricated plots” and “doctored” recordings of the alleged transgressions, Turkey’s reputation and its economy have suffered. Anti-censorship campaigners were appalled by Erdoğan’s bans on Twitter and YouTube, moves subsequently branded by the constitutional court as illegal, with a US government official calling them the “21st century equivalent of book burning.” There were also concerns at the widespread sackings earlier this year of police and justice officials associated with investigating the various corruption claims against the Turkish prime minister. Occasional skirmishes with neighboring Syria have also done little to settle nerves.


Ayci, Ispat: The good news is the robust performance in exports and industrial production.

Investors are understandably concerned at how the prime minister of a country that aspires to be one of the world’s top 10 economies and has more than $20 billion of large infrastructure projects in the pipeline— which are to be financed largely with external loans—can behave like this. The big worry is that Erdoğan may change AKP rules so he can stand as prime minister for a fourth time next year, which means there may be no end in sight to the uncertainty. The fact that parliamentary opposition is ineffectively divided between the Nationalist Movement Party (MHP) and mainstream, secularist Republican People’s Party (CHP) has reinforced the sense of division.  

The question is, what will all this mean for the economy?

Local financial markets initially responded well to the AKP’s victory, with Borsa Istanbul opening 2% up and the lira—which, before January’s interest rate rise, had seen its dollar value slump to almost 2.4—hit a two month high of 2.2.

Economic news has been quite good. Fourth-quarter GDP figures suggest growth last year was rather better than expected at 4.4%, fueled by consumer and government spending: The former rose 5.3%, reflecting an upsurge in bank lending, while ahead of the March elections the latter jumped 6.8% year-on-year, against 1.7% in the same period in 2012. For 2013 as a whole, GDP grew 4%.

“This performance was achieved despite the increased financial volatility sourced by the Fed’s switch to monetary tightening; global, regional and political tensions; the contraction in our biggest trade partner, the EU; and high oil prices,” declared Turkish Finance minister Mehmet Şimşek.

Moreover, the trade deficit—a driver of the current account deficit, which is currently around 8% of GDP—has declined sharply on the back of a lower lira; in February, the trade deficit was $5.1 billion, some 27% lower than in February 2013, with imports down almost 6% and exports up by 6.2%. With conditions recovering in the EU, Turkey’s biggest trading partner, a strong export performance is expected to continue. Inflation is expected to continue to hover at around 6% to 8%, although 2014 may see an uptick to around 10% in the wake of the lira devaluation. “The good news is the robust performance in exports and industrial production, while the current-account deficit was $4.9 billion in January, a decrease of 16%. These early figures make us confident about growth in the near future,” says İlker Ayci, head of Ispat, Turkey’s investment promotion agency.

Moreover, Turkey is now home to 37,000 companies with foreign capital, against just 3,200 in 2012. The aim, according to Finance minister Şimşek, is to increase the number of foreign companies to 150,000 over the next 15 to 20 years.


Things are moving forward. Turkey is now the fifth-largest auto producer in Europe, exporting some $21.5 billion of vehicles last year, an annual rise of 12%. Hyundai has boosted investment in its Turkey operations and is to start production of a new SUV there; Chinese truckmaker Sinotruk is looking to build heavy commercial vehicles in Turkey; and Ford has said it will invest $1.6 billion by the end of 2014, against $1 billion planned in 2011. 

Tourism remains healthy, with Turkey now the sixth-most-visited country in the world, according to World Tourism Organization figures. Some 36 million arrivals were registered in 2012, with more visitors expected this year, thanks to the gradually recovering global economy and the lower lira. Altogether, the tourism sector contributes some $32 billion to Turkey’s economy.

Jackson, Capital Economics: Weaker growth may chip away at Erdoğan's popularity.

There is also huge untapped potential in Turkey’s financial sector, especially in insurance, where only a fraction of Turkey’s 76 million people have cover. The Insurance Industry of Turkey suggests this market is growing fast: The total value of premiums last year, some $11 billion, was up 22% on 2012. And Western banks continue to view Turkey—which plans to develop Istanbul as a global financial center—favorably; Goldman Sachs is to open an office later this year, and Japan’s largest bank, Bank of Tokyo-Mitsubishi UFJ, is to open a subsidiary. 

There are other reasons for optimism too. Government debt is relatively low by European standards, at around 37%, and foreign currency debt is just 13% of GDP. However, the long-term problem remains of Turkey’s low foreign direct investment relative to its size and potential. Last year FDI inflows were just $12.9 billion (4% down on 2013) with some $3 billion of foreign investment in real estate providing little in terms of multiplier value to the wider economy. Net FDI is equivalent to just 1.2% of GDP. 

Even more alarming is the extent to which Turkey is becoming dependent on short-term capital flows. Three years ago net FDI accounted for half the current-account deficit, but between August 2012 and August 2013, it underwrote just $7.3 billion of the
$56.7 billion deficit. Most of the remainder was financed through short-term foreign capital flows. Dependence on these flows and on imported energy supplies—which, in turn, help sustain the high deficit—have become a major vulnerability. 

Against this background, some have doubts about the sustainability of growth. Concerns have grown following January 2014’s aggressive interest rate hike (which included a more than doubling of the weekly repo rate to 10%, amounting to a tightening of some 600 basis points since late 2013). Turkey will always need access to international capital to fund its current-account deficit and ongoing infrastructure plans, but it may have to pay considerably higher risk premiums if fundamentals decline.

“If domestic tensions continue throughout the next electoral cycle, this will impact on borrowing costs,” warns Bojan Marković, Turkey economist for the EBRD. 

All this will negatively affect GDP growth, with most analysts expecting GDP to grow by 2% at best, or half the government target. Things may be about to get worse. Turkish consumer confidence fell to a four-year low in February, reflecting the credit squeeze that has followed monetary tightening. Indeed, Capital Economics’ Jackson reckons tightening will lead to a drop in bank lending equivalent to 2% of GDP, roughly in line with the drop in 2011 to 2012.

“Back then, the economy was only saved from a full-blown recession thanks to a surprising surge in gold exports. But a repeat of this seems unlikely, [so] in the absence of an improvement in financial market conditions or a rebound in export growth, Turkey is at serious risk of entering a recession” says Jackson.

Turkish Banks: Starting From A Strong Base

Turkey’s financial sector, unlike those of many other emerging markets, has emerged as a pillar of its economy. Thanks to deep-seated reforms initiated after Turkey’s 2000­–2001 financial crisis, the banking sector remains well regulated and supervised, with subsequent legislation—in areas like credit cards and mortgages—reinforcing a reputation for prudence. Five years after the global economic crisis, nonperforming loans average below 3% and capital adequacy ratios average around 16%.

Foreign banks are increasingly keen to get a local foothold, a process that corresponds to Turkey’s desire to establish Istanbul as a major financial hub. Islamic banking is also attracting foreign interest, with Qatar Islamic Bank negotiating in early April to buy shares in Turkish Islamic lender Bank Asya.

However, new challenges are on the horizon. Falling consumption in a slower credit environment coupled with rising financing costs will inevitably be reflected in banks’ bottom lines, and a rise in nonperforming loans as the economy slows seems to be inevitable.

In February, Standard & Poor’s cut Turkey’s credit rating from stable to negative, warning that the policy environment is becoming less predictable and that it saw “constraints on the independence and transparency of the central bank,” as well as the growing risk of a hard economic landing. 

On March 24, ratings agency Moody’s placed 10 Turkish banks on review for a possible downgrade, citing tightening conditions and a tense political environment, which, it said, is heightening Turkey’s external vulnerability.

Most observers believe banks will be well placed to ride out the current storm, however. Fitch is maintaining a stable outlook for the sector, with 17 banks, accounting for 90% of the sector, rated as investment-grade. Although it acknowledged that conditions would get tougher over 2014, with a deterioration in asset quality, slowing credit demand, squeezed margins and rising refinancing costs, healthy capital adequacy ratios and other strengths suggest the sector will remain broadly healthy.

Those within the sector echo this. “Today, the biggest challenge for the banking sector is uncertainty, which increases funding costs,” says Hüseyin Özkaya, CEO of Odeabank. “We do not expect a credit squeeze, but loan growth will decline significantly from around the 30% level to 10% to 15%. Thus profitability will decline, compared to 2013.” He stresses that even during downturns, the sector has always managed to turn a profit; post-Lehman, he says, the sector’s return on average assets was 2.6%, even as the economy
contracted 4.8%.

“There may be more challenging times ahead for the banks, but they are starting from a strong base,” believes Bojan Marković, Turkey economist for the EBRD. 

Marković says that over the past 10 years there has been a shift away from the dollar toward the lira, reinforcing stability. However, he says Turkey needs to address deep-rooted structural issues in the sector that are impacting the long-term growth outlook. These include a low domestic savings ratio (currently around 12%); underdeveloped, insufficiently liquid, local capital markets; sustained dependence on often-volatile foreign capital; and a relatively poor record of banks’ lending to SMEs.

Turkey’s local capital markets are simply not adequate for a country of its size, or with its ambitions,” he says.



What can Turkey do? Exports can clearly play a big role, so the priority must be boosting the business environment to improve access for long-term FDI and local SMEs. There is much that can be done: Turkey is in 50th place in Transparency International’s Corruption Perceptions Index. Policy can also play a role. Brainard of Trusted Sources points to the energy privatizations of recent years as almost a casebook example of what not to do to attract long-term foreign capital. “The process was so nontransparent and convoluted that some potential investors didn’t bother, while many that did probably wished they hadn’t,” he says. 

Marković of the EBRD agrees the government should focus on boosting net-export-oriented sectors but also energy efficiency projects, as well as agribusiness; supporting SMEs in the less-developed regions is another key priority. But he admits the current political mood is a problem.

“Political uncertainty is affecting the pace of reform—and therefore the inflow of long-term FDI,” he says.

Following the local elections, the AKP looks unassailable, with the prime minister well positioned to hold on to power and maybe even opt for a fourth term. But over the longer term, a declining economy could unravel support for him.

Capital Economics’ Jackson says: “Weaker growth may chip away at Erdoğan’s popularity ahead of August’s presidential elections. If so, we wouldn’t be surprised to see fiscal loosening to bolster support, although this would reinforce existing vulnerabilities.” Data Summary: Turkey

Central Bank: Central Bank of the Republic of Turkey

International Reserves                 

$87.9 billion

Gross Domestic Product (GDP)

$817.3 billion*

Real GDP Growth







GDP Per Capita—Current Prices


GDP—Composition By Sector*  

agriculture: 9.2%












Public Debt (general government
gross debt as a % of GDP)







Government Bond Ratings

(foreign currency)

Standard & Poor’s




Moody’s Outlook


FDI Inflows


$8,411 million


$9,038 million


$15,876 million


Foreign Direct Investment: STILL RISING

Any suggestion that Turkey’s appeal to foreign investors is dimming is firmly rebuffed by İlker Ayci, head of Ispat, Turkey’s investment promotion agency. Pointing to FDI inflows in January 2014 that show a 50% rise on January 2013 and to total FDI stock that is now $132 billion, he says confidence has become entrenched over the past decade.


“According to the OECD, average annual real GDP growth rate of 5.2% [is expected] between 2012 and 2017, [making this] the fastest-growing OECD economy,” Ayci says, adding that meanwhile, “Turkey is constantly improving its investment climate.”


As proof, he points to the Coordination Council for the Improvement of Investment Environment, on which the private sector makes suggestions, and the Investment Advisory Council, which includes senior multinational executives who “meet to address administrative barriers to investment... and provide a global perspective to the ongoing investment climate reform agenda.”


Looking ahead, Ayci argues that foreign investors will be attracted by the government’s ambitious Vision 2023, which aims to transform everything from healthcare to education and defense.


Turkey aims to be one of the top 10 economies in the world, with a GDP of $2 trillion. Its aims to increase exports to $500 billion, to upgrade energy, transportation and health infrastructure...and build new bridges on the Bosphorus and the Dardanelles straits,”
he says.


Railways, until now relatively neglected, will receive a big boost; the aim is to have some 7,000 miles of high-speed network operating by 2023, connecting more than 29 cities around the country.


That’s not all. The government is planning a vast overhaul of Turkey’s obsolescent urban and semi-urban housing stock, replacing more than a third of its 20 million buildings at a cost of $400 billion. Ispat reckons this will make Turkey’s vibrant real estate sector even
more attractive.  


Ayci says that Turkey is strongly promoting energy to enable this transformation. Investments worth $100 billion are planned, with foreign investors expected to play a major role in forthcoming power privatizations, as well as future greenfield projects.


However, other Turkish officials are less sanguine about Turkey’s investment environment.


“Frankly, too much of the investment we’ve been getting is short-term; the risk is that much of this will take flight as federal tapering proceeds,” says Baris Ornarli, Washington representative for Tusiad, Turkey’s main business and industry association. “Turkey is in a very fragile position.” 


He says the stability that the AKP presided over until around two years ago has evaporated; ongoing political volatility, including attacks on freedom of speech, have tarnished the image Turkey worked so hard to build up.


A lot of tech companies have been considering investing, but we need to be able to assure Internet freedoms, if they are to make that final step.”


Ornarli says the business community is virtually unanimous in arguing that Turkey’s best hope is returning, properly, to the EU accession process.

“Things started to go off track when we lost sight of that goal. Yet I remain confident about Turkey as a country and a business destination. We are a serious people with a high level of maturity and can achieve great things.”