Author: Justin Keay

Enjoying The Good Times


By Justin Keay



Turkey is enjoying unprecedented economic stability and growth. Its biggest challenge is to maintain its balance.



300_Country_Report_Turkey_May-11_1 These days in most developed economies, the release of GDP figures is typically greeted with soul-searching as commentators struggle to understand why it is taking so long to climb out of recession. Really bad figures—such as the unexpected 0.6% contraction in UK growth in the last quarter of 2010—can even cast doubts over policymaking, in that case whether fiscal retrenchment was going too far. By contrast, Turkey’s growth performance has been shaking the market for rather different reasons.


Even the most bullish analysts were surprised by the announcement on March 31 that Turkey’s GDP grew by 8.9% in 2010. The sharp rise was fueled by a surge of 9.2% in the last quarter of 2010 compared with the same period a year earlier and a 5.2% rise in the third quarter. Most observers expected growth for the year would be 8% at best, with the last quarter slowing rather than accelerating.


The figures reinforce the image of Turkey as Europe’s BRIC. Robust domestic demand—driven by consumers, companies requiring manufacturing inputs and the government’s ambitious infrastructure plans—coupled with a healthy export performance have made this Europe’s fastest-growing economy. And not just in 2010: According to the Investment Support and Promotion Agency of Turkey, annual GDP growth between 2002–2010 averaged 4.8%, higher than Poland’s 4.5% or Brazil’s 4%, while inflation and interest rates are both at historic lows.


Financial inflows have been healthy, putting upward pressure on the Turkish lira. And although the global downturn and the winding down of the privatization program slowed it in 2009, foreign direct investment (FDI) was growing again in 2010. Turkey’s total FDI by end 2010 had reached $94 billion, significantly up from the start of the decade, although the highest inflows were between 2006–2008 when privatization was at its peak. Inflows last year were $8.9 billion, a slight improvement over 2009 but well down from the pre-crisis peak of $22 billion in 2007. Over 26,000 foreign companies now operate in Turkey.


“Once upon a time, Turkey was a land of promise and potential. Today it is realizing this potential and emerging as an economic engine for Europe,” Suzan Sabanci Dinçer, co-chairperson of DEIK/Turkish-British Business Council told a packed investor conference in London in late March.


Finance minister Mehmet Simsek echoed the assessment, stressing that favorable demographics—Turkey has one of the youngest workforces in Europe—and the responsible, consistent policies followed since the AKP government first came to power in 2003 have proved a winning combination.


"We offer emerging-market
growth with a developed
country profile"

Even if Turkey fails to secure full membership of the European Union “for us,either way, it’s a win-win situation” — Mehmet Simsek, finance minister

“We offer emerging-market growth with a developed country profile,” Simsek said, stressing that even if Turkey failed to secure full membership of the European Union, its effort to reach that goal, which has obliged it to modernize its institutions and implement significant regulatory and other reforms, was vital. “For us, either way, it’s a win-win situation,” he said.


Even ratings agencies appear to agree, with Fitch noting at the end of 2010 that it expected general government debt to fall to around 40% of GDP—a stark contrast to the bad old days of the 1990s, when it was above 100% of GDP—while inflation, which had sunk as low as 4.2% by February this year, was at a record low. Upgrading Turkey’s sovereign debt outlook from stable to positive, Fitch said a further upgrade to investment-grade is possible provided there are no political shocks, no major slippage in fiscal policy and no significant macroeconomic instability. “There is increasing confidence that a lasting transformation in the country’s economic prospects is under way,” says Ed Parker, head of emerging Europe sovereign ratings at the agency.


A Long Road

Turkey’s radical transformation from the dark days of 2001, when a banking crisis threatened the economy’s foundations, inflation and interest rates were sky-high and forex crises were frequent, is palpable, and not only in cities like Istanbul, Ankara and Izmir. New shopping centers abound, catering to the sophisticated, Westernized tastes of shoppers, whose buying power has been buoyed by the strong lira. The Cevahir shopping mall in Istanbul is the largest in Europe, while the three-year-old Forum mall in Trabzon is the largest in the Black Sea region. And although Turkey still has pockets of poverty—notably in the Kurdish southeast, where unemployment is well above the national rate of around 12%—provincial towns are feeling the benefit of this new prosperity.



Turkish PM Erdogan: Re-election hopes

It isn’t just shoppers who are feeling on top of the world. A new sense of purpose suffuses Turkey’s foreign policy, with Ankara, irritated by the EU’s foot-dragging on its membership hopes, rediscovering old Ottoman-era links in the Arab world, the central Asian republics and the Caucasus. Fadi Hakura, Turkey specialist at London’s Chatham House think tank, says trade underlies this, with Turkey keen to compensate for lower export demand in its main market, Europe, by accessing new markets.


However, there is also a new confidence in Ankara’s dealings with Brussels and Washington, with the AKP sweeping aside criticisms about creeping “Putinization,” specifically that it has been impinging on media freedoms with the arrests of journalists reporting on the ongoing Ergenekon case, a complex saga of ultra-nationalists linked to the military being accused by the government of seeking to undermine it.


Separately, the government made clear its opposition to bombing Muammar al-Qadhafi’s forces in Libya (Turkey has close commercial links with the Tripoli regime) even though it subsequently declined to veto NATO’s assuming control of the operation and subsequently agreed to take over the administration of Benghazi port and airport.


Danger Signs

With parliamentary elections scheduled for June 12, most opinion polls suggest the ruling AKP will win a third victory with around 36-40% of the vote. The main opposition Republican People’s Party (CHP) looks set to win a good 10% less than this. The only questions are whether prime minister Recep Tayyip Erdogan’s party will win enough support to rule on its own and to change the constitution. Erdogan has made no secret of his preference to shift to a presidential system, although president Abdullah Gül opposes this. “In political risk terms, the election looks set to be something of a non-event. It’s what happens after that will matter,” says Wolfango Piccoli, Turkey analyst at the Eurasia Group consultancy, who predicts tensions between Erdogan and Gül may rise.


The government will also have to take action to prevent the economy from overheating, something it hasn’t wanted to do ahead of the vote.


If the 2010 growth rate suggested the economy may be overheating, then Turkey’s current account seems to confirm it. December 2010 saw the deficit hit a record $7.5 billion, well above the worst-case forecasts and the widest gap since the central bank began collecting reliable monthly data in 1984. For the year, the deficit topped 7% with observers expecting it to rise even more over 2011, prompting a large sell-off by investors.  Analysts too have been sounding the alarm. In a late March note, Neil Shearing, senior emerging markets analyst for Capital Economics, a London based consultancy, warned that “the sheer pace of growth and its increasingly unbalanced nature, adds to mounting evidence that the economy is overheating. Turkey’s position as emerging Europe’s star performer is looking increasingly precarious.”



Aware of the dangers but not wanting—yet—to raise interest rates, Turkey’s central bank increased reserve requirements in late March from around 9.5% to an average rate of 13% in an effort to rein in bank lending but kept rates on hold. Fiscal measures are expected to follow after the election, with the government and others forecasting that such slowing will lead to more modest GDP growth over 2011 of around 4.5%. However, such efforts may be offset by Turkey’s huge dependence on energy imports, with every rise of $10 per barrel adding an estimated $5 billion to the deficit.


Spending Supports Growth

“Some clients worry that the current account could widen, leading to inflation picking up sharply, leading in turn to the central bank hiking rates as they did in 2006 and slowing growth, but this is probably not going to happen,” says Charles Robertson, a global strategist for Renaissance Capital.


One big reason is that large-scale infrastructure spending will continue to underpin growth. Some $100 billion is to be spent on the energy sector alone (including building three new nuclear reactors) and another $77 billion on improving water supply. But when spending on new roads, ports, railways (a priority, given the obsolescence of existing stock) and a new bridge and tunnel crossing the Bosphorus are included, total spending will exceed $420 billion. Most projects are due to be completed by 2023—the 100-year anniversary of Mustafa Kemal Atatürk’s founding of the Turkish Republic—and policymakers do not want to do anything that risks spoiling the festivities.


So, assuming oil prices don’t go too crazy and also that carefully targeted monetary and fiscal policies succeed in holding back consumer spending, what lies ahead? One challenge will be to boost FDI inflows. Maintaining competitiveness, once Turkey’s emerging-market competitors get their acts together, will be key. To this end, improvements in infrastructure will help, as congestion and poor facilities in Istanbul have held back Turkey’s growth as a financial center. Another priority is accelerating the development of capital markets. But Turkey also needs to focus on education: Only 8% of the population have university degrees, compared with 15% in Egypt.


In essence, at a time when international capital flows are expected to start increasing, Turkey must work to sustain investor interest by demonstrating it has something its competitors lack. “What Turkey really needs is a story,” says Christian Meissner, head of investment banking for Europe, the Middle East and Africa at Merrill Lynch. He suggests that Turkey, which has long attempted to sell itself as a bridge between East and West, needs also to successfully define itself as a regional hub, as Dubai has managed in the Gulf. In the meantime, Turkey looks set to continue enjoying some of the best macroeconomic fundamentals for many years. After so many long years of false starts and economic crises, these are good times.



Amid an encouraging economic environment, Turkey’s banks, which now number 49 against 86 before the 2001 crisis forced consolidation, have been doing well. Total financial sector assets stood at an estimated $700 billion in June 2010, according to the country’s investment promotion agency, and thanks to prudent regulation by the central bank and the absence of any large-scale investment in dubious financial products, balance sheets look strong.


“The bank sector is very solid—most are well-managed and profitable, and this in a country where mortgage lending is still only in its infancy,” says Wolfango Piccoli, director at the consultancy Eurasia Group. Piccoli believes legislation drafted in 2008 relating to the mortgage business will boost this potentially lucrative market. He says the only surprising thing about Turkish banks is that so few have chosen to expand abroad.


Presumably that has been because they have been making so much money at home. Although householders are no longer allowed to borrow in foreign currency, consumers have been using Turkey’s historically low interest rates as an opportunity to fund purchases of consumer goods, and businesses have take advantage of the environment to fund investment. This has meant more business for banks, which traditionally had the government as their main client.


“Banks have moved a long way from being mere funders of the deficit, an activity that used to absorb 98% of their loans,” said Hüseyin Erkan, chairman of the Istanbul Stock Exchange, speaking at a major investment conference in London in late March. With the government no longer crowding out the private sector, he says, Istanbul’s capital market is well on its way to being the largest in the region (with only a large-scale commodities market missing). The stock market has been booming, while a recent PricewaterhouseCoopers survey found Istanbul the most attractive of 27 destinations for commercial real estate development, with some observers suggesting Turkey is positioned to realize its long-held dream of becoming a major financial center.


Akbank’s CEO Ziya Akkurt echoes this confidence, saying that although Turkey is now more connected to global financial markets, risks remain low. “The capital adequacy ratio averages 19%, while leverage ratios are low compared to those of typical international banks,” he says.


Tolga Egemen, executive vice president for financial institutions and corporate banking at Garanti Bank, says last year bank deposits climbed by 20% from 514.6 billion lira ($338.6 billion) to 617 billion lira, almost 55% of total GDP, and securitization and syndication loans surpassed $23 billion, after a rise of over $5 billion.


“Our strategy will continue to be cooperating closely with our customers in all segments and increasing our volume of business,” he says.


He admits, though, that 2011 will not be as straightforward as last year. “The main challenge for the banking sector, and Garanti, will be maintaining profitability when margins are decreasing. The decision to increase reserve requirement rates, to decrease consumption through slower loan growth, will further affect margins,” he adds.