Country Report Turkey
Turkey’s large current account deficit and its small stock of foreign reserves make it vulnerable to the effects of tapering by the US Federal Reserve. Meanwhile, there have also been several important political developments.
Strengths (+) and weaknesses (-)
(+) Low government debt
Public debt was relatively low at 36% of GDP in 2012 and the government has a track record of posting primary fiscal surpluses.
(+) Favorable demographics
Turkey’s working age population will continue to grow in the medium term and is relatively well-educated.
(-) Vulnerable external position
Turkey’s high current account deficit (5.9% of GDP in 2012) and relatively low level of foreign reserves is a major vulnerability.
(-) Political tensions
Turkey’s proximity to the civil war in Syria, the conflict with Kurdish separatists that still has not been fully resolved and tensions between the government and other parties the government considers to be its domestic enemies add to political risk.
1. Fed tapering puts Turkey’s macroeconomic vulnerabilities mix under pressure
Since the financial markets started to anticipate the tapering by the US Federal Reserve of its special asset purchase program, Turkey has been one of the emerging markets that have felt the repercussions most fiercely. As Turkey’s current account deficit is relatively high, it stood at 5.9 % of GDP in 2012 and is likely to grow in 2013, and this deficit is predominantly financed by short-term foreign capital, the tightening of the external financial conditions due to tapering has resulted in a depreciation of the Turkish lira, an increase in borrowing rates and a fall of stock prices.
Among the emerging markets that have been affected, Turkey stands a bit out due to its relatively low reserve levels. While Turkey’s foreign reserves totaled USD 130bn, only about USD 45bn (which is equal to 2.2 months of Turkey’s 2012 imports of goods and services) of those reserves are freely usable. This huge difference can partially be explained by the USD 45bn banks hold in foreign currency and gold at the central bank to meet reserve requirements. What is more, foreign reserve levels fell by 12.7% between late April and late July. The government nevertheless wants to limit the fall of the lira. Partially as inflation is quite high in Turkey, it went up to 8.9% yoy in July 2013, the authorities have tightened monetary policy by increasing the overnight lending rate by 50 basis points to 7.75%. The tightening of monetary policy is likely to result in a slowdown of growth in the second part of this year, which would reverse the acceleration of growth seen in the first part of 2013. During previous period of tighter external conditions the Turkey’s economy was able to undergo a relatively rapid adjustment. The recent worsening of external financial conditions has nevertheless increased the risk related to Turkish vulnerable external position. Investor confidence could thereby be negatively affected by political developments.
2. Conflict in Syria poses risks
One of such political developments is the civil war in neighboring Syria. In May, a bomb blamed on the Syrian government killed 52 people in a Turkish border town. Meanwhile, Turkey has received 500,000 Syrian refugees and also hosts the opposition Syrian National Council. The Turkish government, who once was an ally of the Syrian government, now is intent on toppling the government of Mr. Assad. The Turkish government has stated that it is willing to participate in an armed outside intervention. The likelihood of such an intervention has increased after deadly attacks chemical weapons, allegedly undertaken by the Syrian government, took place in Syria in August 2013. It is not clear in what way Turkey would participate in an intervention. However, there is a risk that Syria might retaliate and attack Turkish targets. Furthermore, as a large energy importer, Turkey’s current account deficit could further deteriorate if new developments in Syrian conflict would result in an oil price shock. In this respect, we note that the oil price already went up when the likelihood of an armed intervention seemed to increase in late August.
3. Government maintains hardline approach to its enemies
Domestically, the Erdogan government has continued to employ a hardline approach against those who it considers to be its enemies. This was illustrated very clearly in June, when the brutal police response against demonstrators against the destruction of a park in Istanbul resulted in mass protests. Prime Minister Erdogan initially blamed “the international interest-rate lobby” and western media of organizing the protests. The scale of the protests surprised many. Nevertheless, the economic impact is likely to have been small. So far, Turkey’s popularity as a tourist destination seems not to have suffered. Meanwhile, Mr. Erdogan is now in conflict with Fethullah Gulen, a very influential Muslim cleric who has several media outlets. According to the government, followers of Gulen have infiltrated the police and judiciary. Gulen used to be an ally of Erdogan, but may now instruct his followers to vote on other parties than the AKP in the March 2014 municipal elections. The popularity of the AKP has suffered recently and appears to have fallen below 50%. Nevertheless, it remains by far the most important political force in Turkey, as the secular opposition remains very weak. Meanwhile, in early August the so-called Ergenokon trial was closed. This trial resulted in the conviction of a huge number of army leaders, lawyers, journalists and academics to long sentences. They were accused of making a scheme, including plans to blow up mosques and murder Christians, to discredit and overthrow the ruling AKP. Some of the people convicted were responsible for killing and jailing many so-called enemies of the Turkish state in the past. However, the trials have been criticized for being not fair. According to some critics, they were just meant to show that the AKP had tamed the army.
Turkey has a turbulent economic and political history. Turkey encountered a huge financial crisis in 2001, but afterwards its economy has grown rapidly. The business environment has improved in recent years and Turkey now occupies a respectable 43th place (out of 144 countries) on the WEF’s Global Competitiveness Index. Tourism is a very important sector of the Turkish economy. Furthermore, the country also has a developed manufacturing sector. The export diversification has increased in recent years, which has lowered the dependence on textile exports and exports to Europe. Countries such as Iraq and Iran have become important export destinations for Turkish products. Public debt has fallen in recent years and is relatively low at 38% of GDP in 2012, thanks to structural primary fiscal surpluses and high economic growth. Furthermore, the country has a strong banking sector. However, a high current account deficit, a resulting dependence on short-term foreign capital and low foreign reserve levels lead to a relatively high level of balance of payments risk. The government is trying to reduce this vulnerability by undertaking reforms that seek to address the very low domestic savings rate and the dependency on energy imports, but it will surely take time before these efforts will bear fruit. Meanwhile, the strong economic growth of the past decade has underpinned the popularity of the center- right, socially conservative Justice and Development Party (AKP), which won the 2002 elections. At that time, it took over power from the traditional secular elite, which until then, with occasional help from the military, had governed Turkey. The AKP has remained in power ever since. Meanwhile, the level of press freedom is low in Turkey. The proximity to the war in Syria and the still unresolved conflict with Kurdish separatists add to geopolitical risk.