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Country Report Turkey

Country Report

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Turkey’s economy is heading for a slowdown this year, as external financing conditions deteriorate and the central bank had to hike interest rates strongly to defend the lira. The AKP will likely win the upcoming municipal elections, even as an ongoing corruption probe may cost it some votes.  

Strengths (+) and weaknesses

(+) Low government debt 

Public debt was relatively low at 36% of GDP in 2013 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 (7.5% of GDP in 2013) and relatively low level of foreign reserves constitute a major vulnerability.

(-) Domestic and external 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.  

Key developments

1. Turkey’s economy heads for weaker growth amid US Fed tapering

Turkey’s economy may be heading for a sharp growth slowdown this year, as the country’s heavy dependency on external financing exposes it to the effects of the tapering of the US Federal Reserve’s monetary stimulus. Turkey’s economy had rebounded strongly last year from its almost-standstill in the second half of 2012, posting between 1% and 2% qoq growth in the first three quarters of last year. While GDP estimates for the fourth quarter are not available yet, economic growth last year likely rose to about 4%, up from 2.2% in 2012. The significant strengthening of economic growth was mainly driven by domestic demand, which was boosted by more accommodative monetary policy and ramped-up fiscal spending made possible by strongly rising tax revenues.

This year, however, Turkey could be confronted with considerable funding challenges and a pronounced depreciation of the Turkish lira, as the country’s very large predominantly debt-financed current account deficit  (7.5% of GDP in 2013) and a sizeable external debt load of about 51% of GDP bring about an estimated gross external financing requirement of approximately USD 240bn. Owing to an open net FX position of about USD 164bn at the end of last year, Turkey’s corporate sector is particularly vulnerable to a sustained depreciation of the lira, which could result in strongly rising debt servicing costs and possible numerous defaults, particularly among Turkish small- and medium-sized enterprises with few foreign exchange revenues. Moreover, domestic profits of the sector would likely suffer from slower economic growth caused by weakening foreign inflows, which would further depress its ability to service its debt. While Turkish banks should be able to bear associated losses thanks to their current solid capitalization levels and strong asset quality, rising non-performing loans could compound the negative effect of weakening foreign inflows on bank lending.

Reflecting these risks, the Turkish lira ranked among the emerging market currencies that had been hit hardest by the beginning of US Fed tapering, depreciating from TRY 2.03 per USD in mid-December to a historic low of TRY 2.39 per USD in late January. Apparently bound by political pressure not to hike interest rates ahead of the March 30 municipal elections, Turkey’s central bank initially tried to halt the lira’s slide by selling foreign exchange reserves but eventually resorted to a major interest hike in late January that has so far led to a stabilization of the currency at about  TRY 2.20 per USD. Yet, given very low levels of freely usable foreign exchange reserves, the central bank may be forced to raise interest rates once more in order to defend the lira, which would put additional downward pressure on growth. Meanwhile, exports may benefit from a weaker lira. Overall, economic growth this year may thus decline to about 2% while the downside risks to the outlook are rather sizeable. 

Figure 1: Balance of payments & growth
Figure 1: Balance of payments & growthSource: Central Bank of the Republic of Turkey
Figure 2: Lira depreciation since Jan. 2013
Figure 2: Lira depreciation since Jan. 2013Source: Bloomberg

 

2. Major corruption allegations send shockwaves through Turkey ahead of important elections

Three months ahead of Turkey’s municipal elections, a part of the country’s political elite has been affected by a major corruption probe that led to the arrest of various businessmen, some of which have close ties with the AK party (AKP) of prime minister Erdoğan. Among others, the allegations centered around the possible bribery of politicians in order to obtain building permits. Several ministers whose sons were implicated in the graft probe resigned, while prime minister Erdoğan opted for a large-scale cabinet reshuffle to address rising public disenchantment. Erdoğan next moved into attack mode when a sizeable purge of Turkey’s judiciary and police was initiated in which about 200 prosecutors and thousands of police officers were dismissed or reassigned. The decision was motivated by the prime minister’s interpretation of the corruption probe as a ‘judicial coup’ by members and sympathizers of the religious Gülen-movement, a former political ally of the AKP. Furthermore, following the repeated leakage of confidential information and (possibly fabricated) telephone wiretaps of government members, regulation of the internet was tightened sharply. Even though these measures led to various  demonstrations, recent opinion polls suggest that the AKP’s domination of Turkish politics is not at risk, as opposition parties so far fail to benefit from the current situation. Consequently, prime minister Erdoğan’s AKP will likely win the upcoming municipal elections scheduled for March 30 even as the corruption allegations and the broken ties with the Gülen-movement may cost the party some votes.

Notwithstanding the stabilizing effect of the government’s handling of the crisis on Turkey’s domestic political situation, the increased level of political uncertainty contributes to the current weakness of the Turkish lira. In particular, the lingering risk of a further escalation of the conflict between the government and the Gülen-movement, as well as possibly rising concerns among foreign investors about the rule of law and the checks-and balances of Turkey’s democracy may depress important foreign capital inflows in the coming months. Still, a better-than-expected performance of the AKP at the upcoming polls may alleviate foreign investors’ worries about political stability in Turkey to some degree.

Factsheet of Turkey
Factsheet of TurkeySource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Turkey has a turbulent economic and political history. It 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 44th place (out of 148 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 dependency 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 36% of GDP in 2013, 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 dependency 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. 

Economic indicators of Turkey
Economic indicators of TurkeySource: EIU
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Author(s)
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 64053

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