Talking Up The Turkish Economy

It’s official: According to the Turkish Statistical Institute, the Turkish economy grew by an astonishing 7.4% in 2017, well above most forecasts. That is the highest rate of growth since 2013 and gives Turkey the fastest growth of any country in the OECD and G20.

These numbers are likely to bolster Erdoan’s chances of re-election after he surprised markets in mid-April by calling snap presidential and parliamentary elections for June 24, which many believe he will use to bolster his stranglehold on Turkish politics.

Erdoan said he was calling early elections because of geopolitical tensions in neighboring Syria and his desire to rid the country of “the diseases of the old system.” The latter undoubtedly refers to 2016’s failed military coup and his attempts since then to silence his critics, including the media.

Given the political tensions and economic imbalances at home, coupled with a deterioration in the geopolitical picture, many commentators expected much lower economic growth prospects. But growth in some sectors was even higher in 2017, with construction up almost 9% and services up 10.7% compared to 2016, with only agriculture lagging behind, rising just 4.7% year over year.

“Economic activity went beyond even the expectations of the authorities—they kept having to revise their forecasts upward throughout the year,” says Inan Demir, senior emerging EEMEA economist at Nomura.

Without a doubt, the biggest growth driver was the Credit Guarantee Fund, launched to provide government guarantees for cheap credit to Turkish businesses and SMEs. Inspired by South Korea’s Korea Credit Guarantee Fund (KODIT), the CGF provided 250 billion Turkish lira ($62 billion) in credit across the economy last year.

Amid concerns in some government circles that growth might falter, the CGF was revitalized further in 2018, with some TRL55 billion of fresh capital pumped in, of which TRL25 billion will go toward guaranteeing bank loans for large industrial companies and TRL15 billion will support export-focused companies. Demand for credit reportedly remains strong, with Ziraat Bank, the country’s biggest lender, saying loans and assets each increased 5% in the first quarter of 2018.

Other fiscal measures, including tax breaks on durable-goods purchases, have provided further boosts. Growth is also being encouraged by the ongoing global recovery—notably within the EU, Turkey’s most important market.

Don’t Talk the Economy Down

“An expansionary fiscal policy, infrastructure investment via public-private sector investment and the expansion of the CGF will be main drivers of growth this year,” predicts Serhat Gurleyen, director of research at investment bank Yatrm. He suggests growth will be around 4.5% this year.

“The political landscape dictates a high-growth agenda in 2018,” he says. “In the short term, job creation is the priority; in the medium term the main challenge will be to tame inflationary expectations and the unsustainable current account deficit.”

For a government facing snap elections in June and conducting controversial military assaults against Kurdish militants in Syria, high GDP growth has become something of an obsession. An increase of around 5.5% for this year and next is officially forecast—against the IMF’s more modest 4.3% —with Erdoan criticizing those who talk the economy down.

“Our growth rate—achieved despite all the lies intended to spook investors and the ongoing talk about a crisis—has boosted morale in our society,” Erdoan stated in late March. Opposed to raising interest rates to defend the lira, he railed against those who sold it down against the US dollar and other currencies. “Turkey is continuing on its path with determined steps. No one can bring us to heel using exchange rates,” he insisted on April 12.

Signs are that growth will continue, but at a slower rate—a good thing, given that last year many thought the Turkish economy was overheating, with the current account deficit reaching $47.1 billion against $32.6 billion in 2016—that’s around 4.6% of GDP and the highest of any emerging economy, bar that of Pakistan, at 4.9%—and inflation currently around 10.3%. “Both these figures suggest growth was above potential. The worry is that this could impact investor confidence,” says Demir.

These fears have played out against the Turkish lira, which has lost 45% of its value against the dollar since early 2015. Early April saw further falls, reflecting a wide range of concerns, including the fight against the YPG in Syria and the continuing state of emergency.

“The failure of the Turkish central bank to react to the lira’s fall, the high inflation and current account deficit driven by the overheating of the economy, coupled with the strength of the economy last year—all of this combined has made some investors feel rather nervous,” says Roger Kelly, lead regional economist at the European Bank for Reconstruction and Development (EBRD) in Istanbul, pointing to Moody’s downgrade from Ba2 to Ba.

For some in the market, concern has reached fever pitch, as reflected by Turkey’s bond yields, which are currently higher than Egypt’s despite Turkey having a higher sovereign credit rating. And some have been spooked by the IMF’s warning in late

February that Turkey must tighten fiscal and monetary policy to alleviate overheating.

“I can’t recall a time our clients seemed so concerned about a market. The fear is that these imbalances get out of control, the lira collapses further, making it impossible for companies to meet their foreign loans, and there is then a complete collapse of confidence,” says Charlie Robertson, Renaissance Capital’s global chief economist and head of macro strategy. He adds that he doesn’t think the latter prospect is likely: “When push comes to shove, although it doesn’t want them, the government will agree to higher interest rates to protect the lira—as it has done many times in the past,” he says.

Ties With Russia and China

What is clear is that the government is not sitting idly by. 2018 saw a flurry of diplomatic activity reflecting Erdoan’s determination to broaden Turkey’s economic relations.

In early April, he hosted Iranian President Hassan Rouhani and Russian President Vladimir Putin at a Turkey-Iran-Russia summit, which was criticized by Ankara’s traditional allies in the West. Although Syria was the main focus of the summit, the large number of delegates from both countries suggest that Ankara hopes enhanced trade and investment opportunities will also emerge.

Relations have deepened in other spheres, with Turkey agreeing to buy long-range S-400 missile defense systems from Moscow—to the horror of its NATO allies. It is also working with Russia’s Rosatom on the construction of the Akkuyu nuclear power plant near Mersin on the Mediterranean coast. The plant will be Turkey’s first, and cost some $20 billion (with Rosatom holding some 51% of the project). Due to open in 2023, Akkuyu will eventually supply around 10% of Turkey’s electricity needs.

Turkey also sought to broaden relations with China, seeking funds to finance Ankara’s ambitious infrastructure plans with ICBC Turkey, a local Chinese bank, expected to play a key role.

But a big priority is sustaining domestic growth, ideally without further aggravating the current account deficit and inflation. Amid concerns about the fall-off in FDI—which, at $7 billion to $8 billion, is a fraction of Turkey’s needs—the government is planning a new $32 billion investment-incentive package.

Attention will also switch to boosting investment in infrastructure as part of the Turkey 2023 vision, which will commemorate the centennial of its founding by Mustafa Kemal Atatürk. Completed projects include the third Bosphorus Bridge in Istanbul and the world’s fourth-largest suspension bridge, Osmangazi, across the Sea of Marmara, part of a project that will halve journey times between Istanbul and Izmir to four hours.

Work on Istanbul’s third airport continues, with phase one to be completed later this year. And tourism remains a big priority, with the sector hoping to catapult arrivals to 40 million this year and draw revenue of more than $30 billion, on the back of a cheaper lira and a recovery in the local security situation.

The EBRD’s Kelly reckons exports will also play a bigger role this year, encouraged by the investment incentive package, but also by the cheaper lira and the recovery in key export markets.

“China, the EU and other countries are all growing welland Turkey’s well-developed manufacturing sector makes it well placed to benefit from this,” he says. “However, given the size of this economy, consumption will continue to play a big role.”

For Bahadir Kaleagasi, secretary-general (CEO) of the Turkish Industry and Business Association (TÜSAD), the hope is that growth will be “better quality,” with more attention paid to education, IT and digital technology, and FDI being prioritized. “Turkey is at its best when it acts as a bridge between East and West,” he says. “We need to get back on track, pursue closer relations with the EU, lift the state of emergency and resume democratic reform.”

Arda Ermut, vice president of the Investment Support and Promotion Agency of Turkey (ISPAT), says the government has reduced imbalances, pointing to the introduction of the state-supported private pension system, which has boosted the low domestic savings ratio. Ermut believes attention will now shift toward three priorities: investing in human capital (via enhanced education at all levels), further investment in infrastructure and R&D and innovation in all sectors. And attention will continue to be focused on improving the business environment.

“Before 2002, the number of days it took to set up a company was almost 30,” says Ermut. “We’ve cut it to 6.5 days, and since March we have reduced this to a couple of hours. Investors are now able to establish a company in a half-day by just going to the trade registry offices, and there will be no need to go anywhere else.”

Paul Gamble, head of emerging Europe sovereign ratings at Fitch Ratings, believes 2018 will mainly be marked by a gradual normalization of economic activity. Growth and inflation should moderate, though the current account could deteriorate further. He says much depends on politics – and the international perception of what is happening in Turkey – and points to early April when the rumor was that deputy prime minister Mehmet Simsek had resigned. The Lira and equity markets tumbled, until Simsek tweeted that he was still in place – and they recovered. Gamble suggests the elections municipal ones are due in March 2019 and national ones in November – and how they affect fiscal and monetary policy is a key factor to watch. “The political agenda will drive developments, but so will the external environment,” he says. “Markets have shown they can react rapidly.”