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Turkey: An uncertain investment opportunity

There is an old Chinese curse that says: ‘may you live in interesting times.’ Some would argue that the whole world is experiencing such times as a result of the financial crisis and political upheaval across the Middle East in particular. Yet no country is in the midst of a political and financial watershed like Turkey.

Once known as the sick-man of Europe, Turkey has experienced a decade of unprecedented economic growth that has paved the road for greater ambitions. It currently boasts a youthful population with a well trained labour force and a growing consumer class which has left its politicians and businessmen dreaming of bigger things.

Turkey has big ambitions:

Chief protagonist in the huge change; Prime Minister Recep Tayyip Erdogan has declared ambitions of wanting to make Turkey one of the world’s ten biggest economies by 2023. The fact that this would require an almost 15% growth year on year makes this a somewhat thankless task. Yet Erdogan is not fazed by big challenges as the building of the world’s first transcontinental underground rail tunnel which links the European and Asian sides of Istanbul indicates. Add to this a new airport for Istanbul and a canal project aimed at bypassing the Bhosphourous and Erdogan looks more a visionary and less the run of the mill politician. Unfortunately some see his visions as an affront to democratic values and his latest manoeuvres have made him a hugely divisive figure.

The PM’s initial reforms that proved hugely popular are exhausted and critics point out that the next phase of change under his leadership is one of replacing old undemocratic institutions with his party’s own nepotistic equivalents. The Gezi Park protests of early 2013 were largely predicated upon this. The problem with such unrest is the fact that it makes foreign investors who are necessary for Erdogan to realise his dreams for Turkey, nervous and less willing to invest. This ‘political risk premium’ as it is known will be one of the vital factors in determining Turkey’s economic fortunes in 2014 and beyond.

The Turkish economy has been heavily reliant on easy cash in the global market:

Turkey’s economic fortunes however are not exclusive to the outcome of short term political events but have much to do with global economic policies and less transparent domestic factors.

Turkeys spectacular growth over the last decade was inextricably linked to the ready supply of global liquidity initiated by the US federal reserve. The Fed’s decision in 2013 to taper quantitative easing measures which was later temporarily suspended is expected to hit the Country’s economy hard. When the US announced it’s decision which would mean funds pouring out of emerging markets, Turkish bank stocks lost a quarter of their value between May and September 2013.

Turkish government has warned of a consumer culture:

Erdogan’s response to this has been to blame what he calls the interest rate lobby and in the midst of the Gezi protests threatened to “throttle speculators.” In the banking sector at least Turkey’s saving grace is the huge growth of Islamic Banking or what is politically coined as ‘Participation Banks’. There has been a huge boom within this sector with growth of almost 30% between 2012 and 2013.

More traditional secular banks however continue to be squeezed with Turkey’s political establishment is in no mood to ease the sectors predicaments. Erodogan and his deputy Ali Babacan have openly warned about the dangers of consumer culture brought about through easy credit. Credit card loans have increased by 86% in Turkey since 2010 and the response has been to cap borrowing rates and spending limits whilst increasing minimum threshold for monthly repayments.

Erdogan was not simply pandering when he warned Turks to avoid getting credit cards and this move is also an indication of the bigger problem facing the Country namely its huge current account deficit.

A growth in GDP leads to a increase in current account deficit:

Turkish Finance Minister Mehmet Simsek has played down the tapering of QE by the Fed insisting that funds would continue to flow into the Country. He does however acknowledge the current account deficit of between 6-7% of GDP as an issue in the short term. Goldman Sachs has labelled it as unsustainable with Simsek keen to point out that political stability and structural reform are the key factors in maintaining investment into Turkey. Yet here in lies the problem.

Rising GDP seems to be mutually exclusive with a rising current account deficit in Turkey. The double edged sword can be seen in the fact that Turkey has to import $60 billion worth of energy annually contributing hugely to the deficit and it is merely the tip of the iceberg. As a Turkish central bank paper highlighted in 2010 Turkey has a huge domestic supply side problem.

Despite the huge boom in Turkish exports the net benefit is compromised by the need to import most of the raw material and vital components that make up the final product.  The declining lira to dollar rate should in theory be a boon for the current account deficit by encouraging exports, yet the negligible benefits of this make it a somewhat limited benefit. So far Turkey’s ability to finance the deficit has relied on readily available funds via the US Federal Reserve keeping rates low. A move away from this policy as indicated by the Fed shows the cyclical problem facing the Turkish economy.

Turkey has deep structural problems in its economy:

Structural deficiencies in the Turkish economy go deeper than supply side issues and have much to do with cultural norms of dealing with finance and investment. Ibrahim Turhan Chairman and CEO of Borsa Istanbul the country’s premier stock exchange says as much when criticising the tradition of saving through investing in gold and property. “Ladies buying gold bracelets think they are saving but these are not investment tools.”

Further to this the family model of business dynasties that dominates private ownership in Turkey is an affront to meritocracy and is a hindrance to attracting outside investment needed for the next stage of growth. In Turkey it seems the cream still does not rise to the top that easily.

This is a problem that could have serious implications for Erdogan’s government with Turkey in the midst of political corruption trials which have seen calls for Erdogan himself to resign. The PM suggests a foreign plot to weaken his government but whatever the truth, the fact that the sons of government ministers have been implicated brings up the issue of business ownership. It is another indication that the traditional family owned models and investment strategies of doing business in Turkey will have to be broken.

Erdogan’s personal politics may be hampering foreign investment:

Erdogan himself may have to temper his personalised impact on Turkish political life which it seems is alienating foreign investors and business classes. His position in foreign affairs and support for Egypt’s deposed Muslim Brotherhood has already according to many analysts cost Turkey a planned $12bn investment by the Abu Dhabi National Energy Company, who in August pulled out of a project to develop Turkey’s abundant lignite reserves.

With bank balance sheets brim to capacity and sometimes overflowing in terms of loans to deposit ratio, credit may not be in as ready supply as before. The need for other forms of investment may prove to be the tonic for deeper structural reform that Turkey needs in order to achieve Erdogan’s dreams. For that to happen times in Turkey may have to become less interesting.

Find this interesting? You may also like our ‘Country Analysis Report on Turkey‘.

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