At a meeting in Istanbul, outgoing governor of Turkey’s central bank, Süreyya Serdengeçti, joined Global Finance and a group of key figures in the Turkish banking industry to discuss the country’s economic progress.

: Last year was a good one for Turkey, with projected growth of 5% and performance matching targets and budgets and meeting Maastricht requirements. What can we expect this year for GDP and inflation?
SÜREYYA SERDENGEÇTI , outgoing governor, Central Bank of Turkey: The growth projection for 2006 and beyond is about 5%. The question in Turkey, as it stabilizes its economy, is whether it can go above this projection. If Turkey wants to achieve high levels of sustainable growth in the coming years, it has to continue with the structural reforms unabated, and it may enable it to reach even higher growth rates. As for inflation, as of the beginning of this year the monetary policy regime has been changed into what we call full-fledged inflation targeting, and a three-year horizon has been announced publicly for the inflation rate in the coming years. So this year’s target is 5%, but by next year and the year after that inflation is to be around 4%. With the continuation of tight fiscal and monetary policies, we don’t see why we shouldn’t reach these targets.
TOLGA EGEMEN , executive vice president, Garanti: Five percent growth is important, and I believe it will be achieved, but what is more important is the composition of the growth, plus the legal and tax framework under which this growth is going to be generated. The government also needs to generate a broader tax base.

GF : Which are the most important structural reforms?
SERDENGEÇTI : Banking reform is the most important. Tax reform is second and, thirdly, the social security system problems that the government and parliament will deal with this year.
CÜNEYT GENÇ : general manager, BankEuropa: The first two were very important, but social security must be resolved because every year that we lose is becoming a disadvantage for Turkey. Social security is something that all the people are hoping is resolved within 2006 so we really have to reach our targets.
ZEKI ÖNDER : executive vice president, Sekerbank: In previous years, expectations were always a bit higher than actual performance. Now, economic performance is in line with or even better than the targets. That the growth rate will be at least 5% and the inflation target will be reached is the consensus here.
ERKAN UYSAL : head of research department, Capital Markets Board of Turkey: There are risks that we have to take into consideration when estimating GDP and inflation. In the past, international developments favored Turkish markets, but now there’s a rising trend in developed countries’ interest rates. This may change the flow of funds to Turkey. And in the next year there will be elections, which may also affect the management of the inflation target.
NESLIHAN TOMBUL : managing director and senior representative, The Bank of New York: I don’t believe we can afford to overlook the impact of industrial competitiveness on growth. Turkish manufactured goods are relatively low-value-added and heavily focused on basic durables while energy and telecom costs are among the highest in the world. Similarly, qualified labor costs, which are heavily padded by taxes, are high while productivity tends to run low. Consequently, even if the macroeconomic picture looks bright, the economy still needs further tweaking if Turkish industry is to complete successfully.

GF : Where is Turkey in the process for EU membership? How does the process and eventual membership affect the banks? How will EU membership affect agriculture?
TOMBUL : Agriculture is probably one of the most important subjects that Turkey will need to review with the EU, because it’s an important segment of the economy. But EU member states must first agree among themselves as to what the agriculture policy should be before they can look to restricting and limiting Turkey’s agriculture industry.
UYSAL : The capital markets are getting ready for full compliance; in two years we will become fully compatible with EU regulations. In agriculture, though, we will have real difficulty in the future. There is high government support for agricultural prices, which are higher than international prices. And the proportion of the population involved in agriculture is around 40% or 45%. That’s very high compared to the EU.
SERDENGEÇTI : The Turkish economy has been converging in both nominal and real terms toward the European Union for a considerable time now. The whole process will assume a faster pace now, and the ultimate aim, obviously, is membership. This will also bring more investment from Europe, which is vital for the Turkish economy.
EGEMEN : We’ve come a very long way. As long as we continue with these reforms, whatever is being said about the final full membership is going to be less important. We should not get attached to the final results; the country will benefit from the process anyway.
ÖNDER : The process is a lot more important than the eventual results. It will bring efficiency, increase productivity and competitiveness. Every step we take toward membership is a benefit to us.

GF : Turkey has had an export boom recently but is still running a current account deficit. How can Turkey make its current accounts positive?
METIN AR, president and CEO, Garanti Securities: I don’t think it is possible in the short-term to make the current account positive. Turkey continues to be a big exporter, but imports will exceed that by quite a margin—in the next few years at least. But that will be balanced by the short- and long-term investments from banks, individuals and institutional investors.
GENÇ : I believe positive results will come from increasing exports, not decreasing imports. It will take some time to increase exports. We should probably use our strengths in value-added exports.
ÖNDER : In the long-term, it is a structural issue. Turkey has to come up with certain structural changes with long-term planning to increase its export capacity. In the short term, FDI and tourism are the areas that we should concentrate on as a remedy.
SERDENGEÇTI : Before talking about stabilizing the current account deficit, we have to think about why we have a current account deficit in the first place. Investments in this country by far exceed the savings rate. Connect to that the spectacular growth rates in the economy, and definitely the current account deficit and the high growth rates are linked. Now could it stabilize and be sustainable in the future? When we look at what happened in Eastern Europe in economies in the 1990s and afterwards, we see that large current accounts can be sustainable depending, of course, on the composition and amount of financing and the balance of payments. What makes me more confident about the large current account deficit is the fact that tight monetary and fiscal policies are still in force. As for exports, we have seen an increasing competitive power of Turkish industry thanks to macroeconomic stability and to the huge increase in productivity. We see a dramatic change in the composition of the Turkish capital account, which was very much dominated by “hot” money flows in the past. The percentage of hot money is falling dramatically as the share of medium- and long-term financing and FDI increases.
TOMBUL : One of the most important things that Turkish companies can do is to try to capture a larger share of the “value-added” chain. In textiles, for example, margins are very thin, but through collaboration and strategic mergers, Turkish companies can invest in and acquire European brands—because Turkish companies are for the most part producing the goods being sold into Europe under high-margin brand names. Capturing a larger share of the value chain would improve margins and expedite growth.

GF : Privatization has had a bumpy ride in Turkey. What is the current state of the program?
AR: It has been a very successful journey over the past year or so, despite the bumps. There was about $34 billion of privatization coming from Ankara—of which about $27 billion has been finalized, with about $6 billion or $7 billion to be finalized sometime this year. Some of the privatization results in FDI as well, which is an answer to the problem in the current account deficit. The fact that foreign investors are investing in privatizations is also encouraging other FDI.
GENÇ : Turkey’s performance is really exceptional. One thing it should improve, though, is the legal structure of privatization. If investors see court cases after privatization, they might be discouraged.
EGEMEN : As important as how much privatization has been done is how we are going to use this money. Hopefully the government will use the proceeds in repaying debt. Second, while some people think the court decisions cast a shadow on privatization here, in my view they are reflections of a strong legal system in Turkey.

GF : Turkish banks have made a remarkable recovery since the 2002 crisis. How did it happen, and will it continue?
SERDENGEÇTI : Many measures have been taken by the independent banking supervisory institution. The process continued with increasing mergers and acquisitions in the financial system. Foreign participation has increased over this period, but we have also seen domestic mergers. Finally, the banking law was amended again last year, which probably has also contributed to the health of the banking system.
TOMBUL : The crisis was probably the best thing that could have happened to the banking sector. It allowed the strongest to emerge, and it brought incredible shareholder accountability to the banking system, which it didn’t have before. Third, it encouraged better risk management.
ÖNDER : Marketing of banking products and services, as part of the switch to so-called real banking, has also helped. We see tremendous growth in banks’ performance and at the same time development of lending facilities. Banks are able to fund themselves in the international markets continuously at better conditions, and they are in a tremendous growth environment.
EGEMEN : The most important development has been the change in the composition of the revenues of the banks. They’ve been as profitable in the past as they are today, but in the pre-crisis period most of the profits came from non-customer-related activities. Today, most of the banks have managed to shift into customer-driven profit-generating businesses. The profits of the Turkish banks today are therefore perceived as more sustainable.
UYSAL : With the opening of the futures and options exchange, there are now currency futures, interest rates futures and other futures. Today banks can manage their currency risk much better compared to the past, but regarding the interest rate risk they don’t seem to be interested in futures and options. The volume of trading has been zero since Izmir Futures and Options Exchange started its operations.

GF : Banks of many nationalities seem to be enthralled with Turkey, and increased valuations don’t seem to be deterring their plans for entry. How will this all end, and will it be good for Turkey?
UYSAL : We have seen intensive interest of foreigners in Turkish banks, basically due to the relatively high margins. We had troubles in the recent past, and reforms were introduced in the banking sector. However, more institutional reforms are expected in the near future. In the Turkish banking sector, increased demand for consumer borrowing in the domestic market and high growth potential are tempting in foreign banks.
AR: There have been four major bank acquisitions or mergers in the past year or so. Three were acquired at higher valuations compared to their Istanbul Stock Exchange valuations, but today they’re all at much higher valuations than their acquisition valuations. I question, though, if any one of them were to be executed today, would they be executed at above or below the Istanbul Stock Exchange valuation? I would guesstimate they would be executed at lower levels than today’s market capitalizations. The ongoing pipeline of banks being considered by international investors might have a problem with their existing and high Istanbul Stock Exchange valuations.
GENÇ : There’s a lot of interest in Turkey because of the sustainability of the economy and also the developments and improvements that are going on, but foreign investors have to be careful with the increasing valuations. These increasing valuations may lead to some unsuccessful acquisitions for some foreign banks. There is very good potential for growth, but they should never come to Turkey because it is the fashionable country to invest in.
EGEMEN : When people talk about the concern over the fact that foreign banks’ involvement is increasing, one probably needs to look at the share of foreign banks—whether or not they control the management. If you look at the foreigners’ shareholding, in fact it is much higher than what we talk about these days, but you see very little management involvement from the foreigners, even in the fully foreign-controlled Turkish banks. Turkey will be more similar, if you ask me, to the Brazilian case rather than Argentinean or Eastern European emerging market cases. The existing banking culture is strong, so regardless of what level of foreign capital comes into the banking sector, we will continue seeing the locals managing and controlling the banking sector.
TOMBUL : Foreign banks are entering the Turkish market in order to benefit from Turkey’s exciting demographic profile with the hope of capturing market share. One question, though, is where will the growth come from? Many of the local banks are betting that it will come from consumer and retail banking and mortgage banking, but even then there first has to develop critical mass before banks can build market share in these markets. The success of retail and consumer banking relies heavily on the development of an affluent middle class. Per capita income is still relatively low, and income distribution is terribly skewed, and until we see a significant rise in wealth levels, banks will struggle with profitability from these business lines.
ÖNDER : There is a very strong interest shown in Turkey because of the potential, and I think it is good for the short-term because banking in Turkey is actually really developing for the first time for the masses. You are talking about all kinds of banking, from primary agriculture to development banking. Turkey has a huge potential. Turkey has a very strong banking practice and history. Definitely there will be Turkish banking, Turkish management—definitely they will have a strong domestic content. However, in the long term, we will see how the market and competition will shape up. Some of the players may choose to leave.