Turkey: Investment Draw

Despite political unrest, and criticism from trading partners, Turkey continues to draw foreign direct investment. Can FDI help it return to economic expansion?

Going by the numbers, economic matters are looking up for Turkey. Second-quarter performance came in better than anticipated, prompting two leading forecasters to bump up their growth forecasts for the year. Fitch now anticipates the economy will contract just 0.3% in 2019, versus the 1.1% contraction it had earlier penciled in; and the European Bank for Reconstruction and Development (EBRD) predicts a decline of just 0.2%. Both anticipate growth over the next two years.

“Credit growth, fiscal stimulus and rising consumer confidence” will propel the economy next year, the EBRD says in its latest annual forecast, suggesting GDP will rise 3.1% in 2020 and 3.6% the following year.

Good news on the inflation front has also helped, though some doubt official Turkish statistics and others anticipate a rise in inflation in coming months. The headline number fell to 8.6% in October, sparking predictions that the benchmark interest rate, trimmed three times since hitting 24% last fall, to less than 14% in October, will drop to 12.5% by January. President Recep Tayyip Erdoan wants to see rates in the single digits as soon as possible to further kick-start the economy.

Yet if this is a recovery, it’s starting from a most difficult place for investors. Even the more optimistic forecasts concede that the economy is contracting this year. Meanwhile, growing authoritarianism is undermining democratic institutions; and the army’s incursion into northern Syria to push back Kurdish fighters has upset a tenuous balance of power in Turkey’s war-torn neighbor.

But the threat of new US sanctions lifted, following Erdoan’s recent visit to Washington and an agreement between Ankara and Moscow to jointly patrol the buffer zone adjacent to Turkey’s border with Syria. And while individual members of the ruling Justice and Development Party may face sanctions, and there remains a threat hanging over Turkish state-owned bank Halkbank over its alleged violation of sanctions on Iran, the wider danger to Turkey’s economy seems to have eased.

One indisputable positive for Turkey has been foreign direct investment (FDI). The latest Global Investment Report by Unctad, released last summer, found that FDI into Turkey last year rose by 13% at a time when global FDI, battered by geopolitical fears, fell by the same amount. In 2018, Turkey signed some 40 international investment agreements, more than any other country, and became the largest recipient of FDI in West Asia. This year, FDI had increased 6.3% to $12.4 billion as of late October, led by companies from Azerbaijan, Qatar and the UK.

This suggests that many investors are discounting present realities and instead taking the long view based on Turkey’s strategic location, its young and generally well-educated workforce and its considerable potential as it moves—hopefully—out of the middle-income trap and toward a high-value-added economy. “Turkey’s location, at the crossroads of Europe, Central Asia and the Middle East, provides easy access to European, Middle Eastern, North African, Central Asian and Gulf markets,” says Arda Ermut, president of Turkey’s Investment Office. “These markets comprise more than 1.5 billion people and account for a total GDP of $24 trillion. More than half of the world’s trade takes place within a four-hour flight radius of Turkey—a key reason why multinational companies have chosen Turkey as a strategic regional hub for their operations.”

Much of Turkish FDI is in the form of joint ventures with large Turkish conglomerates such as Sabanci and prioritizes moving the economy toward more knowledge-based, value-added investments, says Arvid Tuerkner, managing director for Turkey at the EBRD. Although the picture is uneven at present, the longer-term prospects are positive, he says. “I’m sure Turkish FDI will overcome this current difficult phase,” he predicts. “We are seeing strong companies in Turkey who are investing, not just our clients but elsewhere.”

One such project is Volkswagen’s planned $1.4 billion investment in a new car plant in the western city of Manisa, expected to turn out 300,000 cars annually and create 5,000 jobs. Although a final decision about building the plant is still pending, Turkish officials hope that the cessation of hostilities in Syria following the Russian agreement will lead to a final go-ahead. VW would join Ford, Honda, Toyota, Renault and Mercedes, which already have large automotive FDI projects underway in Turkey.

Other key investments this year include Azerbaijani energy company Socar’s planned $600 million injection into the $6.3 billion Star oil refinery, which has the capacity to process 10 million tons of crude oil a year, boosting Turkey’s long-term energy security.

Away from the headlines, Turkey has been working to create a friendly environment for foreign FDI. It has consistently improved its position in the annual World Bank Doing Business survey, moving from 60th place out of 190 countries in 2017 to 43rd in 2018 and 33rd this year. It has some 100 special economic zones, the most outside East Asia, and the Development and Investment Bank of Turkey (TKYB) has announced plans to establish subfunds supporting development in key areas of the economy, including technology, venture capital, machinery and agribusiness.

With assets of more than $3 billion, TKYB has moved its headquarters from Ankara to Istanbul and says it will play an active role in helping meet the government’s objectives for Vision 2023, the list of goals Erdoan announced to commemorate the centenary of the Turkish republic. In 2023, Turkey is expected to become one of the world’s top 10 economies, with a GDP per capita of over $12,000.

The main source of interest in FDI in Turkey, Tuerkner says, has been from companies looking to produce goods for export, as recent devaluations of the lira make Turkish exports more attractive. “The export-orientated companies and sectors, including the likes of the auto industry and white goods, are still very attractive,” he says.

If Turkey is to maintain its appeal, however, it will need to continue improving the business environment, close observers say. Nagging deficiencies range from the general—such as improving transparency and speeding up the judiciary process for resolving commercial disputes—to the specific.

The EBRD has long prioritized green and renewables investments, and half of its €11.5 ($12.7 billion) billion invested in 300 projects in Turkey “promote the sustainable use of energy and resources.” But investment in renewables has been held back, in part because of “the regulatory environment needing to be fully clarified,” Tuerkner says. Whether renewable or not, the energy sector has been one of the most attractive for FDI, Ermut says, fueled by rising domestic demand due to a growing population and recent years of healthy economic growth. “There has been a dramatic rise in total installed electricity generation capacity,” he says. “To satisfy increasing needs, current capacity is expected to reach 110 gigawatts by 2023, through further investments to be commissioned by the private sector.” Liberalization has bought about $18 billion of FDI to Turkey’s energy sector in the past decade, he adds.

Other key FDI sectors, Ermut notes, are information technology equipment, communications equipment and software (ICT), and insurance. The government has prioritized ICT as key to avoiding the middle-income trap, and it has attracted some $16 billion in FDI to Turkey. Finance and insurance have attracted some $52 billion in investment since 2005, much of it lured by the reforms introduced in the early years of the century.