Back to the Future?

Where Turkey’s economy is headed

Turkey has become a popular subject in newsrooms across the West as it asserts itself more forcefully on the international stage, empowered by growing economic clout. But what are its growth engines and are they sustainable?

A decade ago, Turkey was the prettiest girl at the dance. A banking crisis in 2001 had meant Turkey’s financial sector was far better prepared for the 2008 crash than many of its European contemporaries, and as capital took flight from developed markets, Turkey was near the top of the list of EMs that were able to effectively draw attention.

It wooed foreign investors with its large, young population and growing household spending power. Moreover, it seemed on the cusp of EU accession and enjoyed robust relations with surrounding nations, a result of its successful “Zero Problems with our Neighbors” policy.

Here began a period of unprecedented political noise that at times seemed to threaten Turkey’s growth story. A June 2015 general election resulted in a hung parliament and was followed by a snap election in November of the same year.

This coincided with a return to violence in Turkey’s southeast, and just a year later, in the summer of 2016, a failed coup attempt.

Mere months later, in April 2017, Turks went to the polls again in a referendum on constitutional change. With the “yes” vote claiming victory, Turkey will adopt a presidential system following parliamentary and presidential elections in 2019.

But what has all of this meant for the economy?

Turkey has not been immune from strains on global EM currencies over the last year, with the lira joining currencies from Mexico to South Africa in decline. Political issues in Turkey have played their part, yet recovery in the US and Federal Reserve rate expectations, among other factors, also clearly contributed.

Turkey attracted USD10.83 billion in net international direct investment last year. 10 years ago, the full-year 2008 figure was USD17.718 billion.

So what should we expect going forward?

A key campaign point of the government in the recent referendum was that a transition to a presidential system would make it easier for the government to take decisions and boost the economy. They have promised “swift and bold” reforms that will boost exports and employment.

The Turkish economy grew at an impressive rate over 2017, at around 7%, driven to some extent by strong fiscal stimulus packages and export market recovery. Turkish exports had taken a hit after 2008 as Europe entered a downturn, turning instead to markets in the Middle East to pick up the slack.

In that respect, stronger growth in Europe came just in time as the eruption of civil conflict from Western Sahara and Libya to Iraq and Syria hurt Turkish businesses, especially those used to lucrative construction contracts across the region.

In late February, the IMF raised Turkey’s growth forecast by 0.5 points to 4%—more moderate than 2017 as a result of “weaker policy-driven impulse.”

This coincides with the likely withdrawal of fiscal stimulus in 2018. In that respect, the government needs to strengthen business and household sentiment, damaged by the uncertainty of recent years.

Consumer price inflation remains above the target, dulling the appetite of consumers. The central bank made its first rate hike in eight months in December in its quest to fight inflation pressures, resisting calls by Turkey’s leadership for cheaper credit to boost the economy. This has raised concerns over the future independence of the bank.

The government’s hunger for growth is tied to its electoral success. Indeed, the ruling party has maintained its popularity through the unprecedented economic growth it has overseen. Since 2002 when it was first elected, the economy has grown from USD238.4 billion to USD857.7 billion in 2016. GDP per capita has increased from USD8,000 to USD14,000.

The government hoped to ride that wave all the way to its 2023 Vision goals, a date that will be significant as the centenary of the foundation of the Republic. Among the lofty targets are GDP of USD2 trillion, exports of USD500 billion (currently USD150 billion), and GDP per capita of USD25,000. Most of these goals now seem unlikely to be attained. The question going forward will be how willing the government is to sacrifice economic stability for growth.

One thing is for sure, though; the government believes that you have to spend money to make money. In that respect, a large number of foreign firms have made huge gains working with local firms on the construction of a series of megaprojects in recent years, mostly focused in and around Istanbul.

A few examples of completed projects include: the Marmaray, an underwater rail tunnel linking the Metro systems on the European and Asian sides of Istanbul, built by a consortium led by Japan’s Taisei Corporation; the 3rd Bosphorus bridge, a consortium of Turkish firms and Italian Astaldi, and Osman Gazi Bridge, the fourth-longest suspension bridge in the world, spanning the Gulf of Izmit, and also developed by Turkish firms and Astaldi; and the Eurasia Tunnel, a road link under the Bosphorus that was partially developed by Korean firm SK E&C.

These projects often follow the Build-Operate-Transfer model, which the government has embraced. Current BOT projects include the construction of a new airport in Istanbul, which will open in 2018 and be one of the world’s largest; a series of “city hospital” PPP projects; and two nuclear power plants contracted to Russian and Japanese-French consortiums.

We asked Markus Reckling Turkey CEO for DHL Express, what his expectations for the airport were. He told us; “Putting aside the current uncertainty and assuming an optimistic scenario whereby Turkey grows 4-5%, the airport could be a great stimulus to the economy.”

But for Turkey, the PPP model allows it to attract and gain know-how, as well as encourage longer-term investment. Encouraging such investment is not easy, though, as Turkey is finding. The largest source of investment for Turkey is Europe.

And with a series of high-profile diplomatic spats between Turkey and countries including the Netherlands and Germany, many European investors are wary of taking the plunge. The continued extension of the state of emergency imposed following the failed coup attempt is also adding to uncertainty surrounding the long-term viability of investing in Turkey.

Interestingly, however, 62% of companies in Turkey that benefit from foreign funds or involvement are linked to near and Middle Eastern countries.

Investors continue to buy into Turkey in the form of equity or debt purchases, yet a dangerous reliance on short-term foreign capital has emerged. So-called “hot money” can leave as quickly as it arrives, and such investors are therefore not as worried about the political climate and the government’s repeated calls for a reduction in interest rates. Of the USD10.83 billion of FDI attracted in 2017, USD7.44 billion was equity investment inflow. High interest for hot money continues to be a reality, and bonds are particularly popular.

On Borsa Istanbul, the mood remains positive. Banks remain consistently some of the most popular equities, while Turkish Airlines, another result of the Turkish growth miracle, is another leader. Another winner is Aselsan, which recently became the most valuable firm on the exchange. Passing Garanti Bank, the company’s success highlights the growing power of the Turkish defense industry, which has launched, among others, a Turkish-made rifle, a tank, and soon a fighter jet.

The Turkish environment is also increasingly high tech, and political uncertainty hasn’t held back the development of a strong culture of innovation. One such growth area is fintech, with Dr. Vahdettin Ertaş, former chairman of the Capital Markets Board (CMB), telling us that “growth in smartphone ownership along with advancements in mobile payment technology has changed the way people conduct their financial transactions.”

And the regulatory environment is also robust, with Mehmet Ali Akben, Chairman of the Banking Regulation and Supervision Agency noting the fact that “regulatory sandboxes seem like a common approach among other supervisory bodies in Europe. We are considering that approach to fintech in Turkey.”

Moving forward, Turkey’s relationship with Europe could be the main differentiator for its business environment. A fragile deal with the EU to stem the flow of refugees into European nations in return for financial support has at times looked likely to break down as the Turkish government clashed with leaders from Merkel to Rutte. Turkey itself is home to approximately 2.5 million Syrian refugees, and Europe’s perceived lack of help has fostered already rising anti-European sentiment within Turkey.

In that regard, criticism of Europe has become a vote winner, yet it is important to understand that during some high-profile fallouts, bilateral business remained unaffected.

Political campaigning at home has frequently spilt over borders, a reality that we’re likely to see far less of post 2019, when Turkey settles into a more regular political schedule of elections and the state of emergency is lifted.

The stability this will bring could see Turkey return its business environment to the optimism of 10 years ago.