Turkey Into The 2020s

What does the next decade have in store for Turkey?

Back in 2010, Recep Tayyip Erdoan, then Turkey’s prime minister, won a referendum on constitutional changes. The country seemed a model of moderate Islam, proceeding with plans to join the EU, and was the darling of foreign investors.

Ten years, several elections, another referendum and an attempted coup later, the terrain over which Erdoan—now president—presides looks less benign. The war in neighboring Syria—which had driven over 3.6 million refugees into Turkey by late 2019, according to government statistics—and a number of terrorist attacks have undermined domestic confidence. Devaluations of the lira led to a big drop in living standards.

Yet Turkey remains a confident country. Witness Erdoan’s announcement that he will proceed with his highly ambitious plan to build a 28-mile Kanal Istanbul connecting the Black Sea to the Sea of Marmara in order to alleviate congestion in the Bosporus—highly controversial because of the huge scale (cost estimates range up to $15 billion) and what many say will be significant environmental damage. A new tunnel under the Bosporus is also being green-lighted, with contracts for the canal and the tunnel coming up for tender later this year. Turkey’s infrastructure plans, mostly funded as public-private partnership projects, have been vast. Some $313 billion of deals are in various stages—from new roads to a new Istanbul airport. All this is focusing minds on Erdoan’s 2023 Vision, which he says will pull Turkey into the world’s top 10 economies. Yet to succeed in pushing new projects ahead, he will have to convince foreign money that Turkey’s economic and policy trajectory is still credible.

Erdoan is targeting growth of 5% this year—some 1.5% higher than had previously been planned for 2020—fueled by the central bank’s 2019 interest-rate cuts. The plan is to drive growth via stronger domestic demand and a recovery in investment following the hit to the economy over 2018, when investor confidence and the lira took a hit during a brief trade war with the US.

Many observers have serious doubts about the sustainability of Erdoan’s growth plans, suggesting they rest on shaky foundations. “Policy loosening will drive a stronger recovery than most expect, but at the cost of higher inflation, a widening current account deficit and falls in the lira,” Jason Tuvey, senior emerging markets economist at Capital Economics, wrote to clients in mid-January.

He and others say investor confidence remains a concern amid continuing doubts about the independence of Central Bank Governor Murat Uysal, appointed by Erdoan after his predecessor was fired last July. The big question is whether he will raise interest rates—anathema to Erdoan—when the circumstances require. As always, it all comes down to Turkey’s dependence on external sources of finance.

“Sentiment toward emerging markets is currently quite positive, but politicians are walking a fine line. [To hit Erdoan’s] 5% [growth target] really will require a big stimulus; and there are questions about the impact on inflation, the lira and the current account deficit,” says Roger Kelly, lead regional economist covering Turkey at the European Bank for Reconstruction and Development (EBRD) in Istanbul. “At present though, it does seem the authorities are prioritizing growth over economic stability.” Kelly’s growth forecast for 2020 is around 2.5%—just below the IMF’s 3%—although he admits 3.5% is also possible.

Fitch Ratings agency is forecasting 3.1% this year and 3.6% next, but reckons that while Turkey’s external financing requirements have fallen from 2018’s $210 billion to around $170 billion, global financing conditions for the rest of the year are uncertain. The company, which on November 1 raised the outlook for the country from negative to stable, sees a mixed picture for 2020 and beyond. Investment is recovering from its contraction last year and is expected to grow by over 4% next; while consumer spending, largely enabled by bank lending, is expected to rise some 5.5% this year.

Despite currency pressures and sluggish loan growth, banks generally remain profitable, with capital adequacy ratios around 17.7% against the regulatory minimum target of 12%. Yet that may change over 2020 and beyond.

“The risk of sanctions has receded; but on the other hand, bank NPLs [nonperforming loans] are on the rise—currently around 6% after a rise from around 4% last year—with many stage-two loans likely in time to become NPLs,” says Douglas Winslow, director and Turkey analyst on Fitch Ratings’ sovereign team. “Capital buffers to help state banks absorb NPLs have weakened, so we could see injections to help them cope.”

Winslow also reckons high inflation will remain a factor, sticking at around 10% after hitting 12.15% in January 2020; this will require interest rates of at least around 12%. He figures investment will recover after falling some 15% last year, probably rising by more than 4% next year.

What other issues will define Turkey in the coming decade? Opposition parties have room to bolster their strength before parliamentary elections in 2023, and maybe even coalesce around a challenger. Ekrem mamolu, the Republican People’s Party mayor of Istanbul, could possibly compete for the presidency. Turkey watchers are also looking at new parties: Ali Babacan, the successful former Justice and Development Party (AKP) economy minister, and former Prime Minister Ahmet Davutolu are forming new parties that seek to win disaffected AKP supporters. Although the 10% threshold parties must pass in order to qualify will make getting into parliament difficult, new parties’ cooperation with other ones could make life difficult for the AKP. Still, most believe the chances of a serious rival to Erdoan emerging are slim.

“The next presidential election is in 2023, which coincides with the centenary of the Republic of Turkey. Erdoan will be playing this for all he is worth,” says Dimitar Bechev, a research fellow at the University of North Carolina, Chapel Hill, who is currently writing a book on Turkey’s past two decades. “Even if the AKP has lost ground, Turkey now has a presidential system, which means he holds all the strings.”

However, he says, that doesn’t necessarily mean plain sailing for the administration. After years of preparing for eventual EU membership, Ankara seems to have abandoned its European ambitions as relations with Brussels have worsened. Its ministry for EU accession merged into the Ministry of Foreign Affairs after the 2018 presidential election.

Instead, Turkey is playing a much more active role in Middle Eastern affairs. Many are comparing its aspirations to the days of the Ottoman Empire, when it dominated the region.

“I don’t anticipate a break with the West; but Turkey will increasingly work as an independent player, open to cooperation with countries like Russia, Qatar and others on its own terms—and its trade policy will echo this,” says Bechev. “That said, the EU is still far and away Turkey’s biggest trading and investment partner; so behind all the rhetoric, cooperation will continue.”

Ultimately, the economy will be Turkey’s most vulnerable spot, with Erdoan’s ambitions very much dependent on the global economy and foreign financial flows.

Observers encourage focusing on the long term. The EBRD’s Kelly says the mood now is more positive than a year ago for many, but perhaps not for the average person in the street.

“It is the absence of a feel-good factor that lies behind the government’s focus on growth, but the government also needs to focus on structural reforms to enable the economy to move up the value chain,” Kelly says. “Without this, Turkey risks being caught in the middle-income trap.”

The government knows what will boost the country’s long-term competitiveness—much of it is in the 11th Development Plan unveiled last summer. Top priorities are development of energy resources and boosting tourism. Additional priorities include better education, more vocational training, development of domestic capital markets and enticement of more FDI.

Going forward, Turkey may need something else. Many are still suffering from the shock that recent currency depreciations wrought on living standards and are leery of Ankara’s growing involvement in regional conflicts. Secular Turks, concerned at rising Islamization, wonder whether Turkey in 2023 will  resemble Kemal Ataturk’s vision of a modern, Westward-looking country.

“This is not the same Turkey as it was 10 years ago. Then, living standards were rising and the mood was positive. Today, there is more disaffection, particularly with the randomness of decision-making. Life has become very uncertain for everyone, including investors and business,” concludes Bechev. “This needs to change.”