Back on track

Has Turkey’s long-troubled and much-maligned economy finally turned the corner? Top-line data would seem to support that view.

Output grew by a stronger-than-expected 4% in 2015, driven by strong consumer spending figures, making Turkey the fourth fastest growing economy among G20 nations.

Nor does this seem to be a fluke. Economic performance has improved consistently in recent years, a fact often overlooked by investors. Output, said Marcus Svedberg, chief economist at emerging market investment manager East Capital, has “accelerated steadily”, from 1.8% year-on-year growth in the third quarter of 2014 to 5.7% in the final quarter of 2015.

What, though, does this really mean? Is this return to economic form semi-temporary or here to stay? Where do the challenges lie for legislators in Ankara going forward – and how can they be pre-empted? And can the pro-reform strategy that served Turkey so well in the mid-2000s be rebooted, giving foreign buyers a solid reason to invest in one of the world’s great emerging markets?

First off, it is important to give credit where credit is due. Few expected the economy to be quite as chirpy as it was last year. A Reuters poll foresaw growth of 3.9% in the full year 2015 and of 5.2% in the final quarter.

“Growth surprised on the upside,” said Bojan Markovic, lead economist for Turkey at the European Bank for Reconstruction and Development. Guillaume Tresca, senior emerging market strategist at Credit Agricole, said: “We have been worried about Turkey for so long, even well into last year. But we were perhaps wrong to fret quite so much. You now have Turkey, regularly hitting 3%, 4% growth quarter after quarter, while Brazil and Russia remain mired in recession.”

To be sure, Turkey’s revival is the net result of a blend of factors. Hiking the minimum wage was a “primary driver” of last year’s strong domestic demand, said East Capital’s Svedberg. The decision by Erdem Basci, governor of the Central Bank of the Republic of Turkey (CBRT), to switch to a more unorthodox monetary policy in 2012–2013, “concerned many at first”, said Tresca. “But it turned out to be a smart move, one that enabled the country to withstand a lot of shocks over the past year.”

Basci left office in April after serving a single term. He leaves his successor, Murat Cetinkaya, an economy in reasonably robust shape, with a current account deficit of 3.6% and headline inflation of 7.5% and falling.

But Turkey can also thank its stars for events and factors far beyond its control. An oil price still below the US$50-per-barrel mark has been an unexpected boon for the resource-poor nation. Then there is the migrant crisis. To European eyes, this seems like a never-ending, ever-unfolding tragedy. Yet to Turkey it has been a mixed blessing, its impact decidedly nuanced.

Dealing with and processing a fluid army of refugees from war-torn Syria has been costly. But, said Timothy Ash, head of CEEMEA desk strategy at Nomura, the “one thing people miscalculated was the impact of 2.5m Syrian refugees. Those not in the camps are working, trading, investing and doing business. The positive impact of refugees was reflected in the US$10bn net errors and omissions inflow on the country’s balance of payments last year.”

The refugee crisis has also transformed the country’s relationship with the European Union. Brussels sees Turkey, for better or worse, as a vast buffer zone standing between the EU and Syria. Ankara, in turn, is happy to keep millions of refugees sealed within its borders, but in exchange for visa-free access to the European bloc for 75m Turkish citizens.

“The refugee crisis has given Ankara a lot of leverage in its relationship with the EU, and it could have material benefits for the Turks as negotiations on membership and other issues progress,” said Emre Tuncalp, an associate at risk consultancy Stroz Friedberg.

Despite last year’s strong economic data, analysts are not getting too excited about Turkey’s long-term prospects. East Capital’s Svedberg said economic growth will plateau, “stabilising at around 4% on an annual basis”.

Others are less optimistic. Nomura’s Ash sees output slowing this year, hindered by soggier domestic demand. “Given political, security and geopolitical risks, I am more in the 2.5%–3% growth camp for this year,” he said.

Roxana Hulea, emerging market strategist at Societe Generale, said there was “no reason why Turkey’s growth should be any less volatile” in 2016 than it has been in recent years. “Nothing has fundamentally changed in its consumption-driven, imbalance-creating growth model,” which depends heavily on strong construction and private consumption data, she said.

Known knowns

Many of the uncertainties the nation will continue to face this year and next are well known. Top of the list is the US Federal Reserve’s monetary policy. This is particularly vital to a country with a large current account deficit and short-term external debt, and which needs to attract large volumes of external financing to fund its import bill and roll over maturing debt.

So far, said William Jackson, an emerging market economist at Capital Economics, Turkey “has benefited from the Fed’s relatively dovish tone, which has supported capital flows to the country”.

Most observers expect the Fed to retain its current policy. But if it does change its tune, hiking rates faster and farther, it will likely push up inflation and prompt the CBRT to reverse its easing cycle, undermining growth.

Then there is infrastructure. Large-scale infrastructure projects such as Istanbul’s new third airport, set to open in 2018, have “driven construction and the economy generally”, said Stroz Friedberg’s Tuncalp. “These [projects] will continue to drive growth in 2016. But they require complex, multilateral financing – and the Achilles heel of the Turkish economy is that it’s very dependent on funds from abroad. If they dry up, because of rising interest rates in the US or a loss of risk appetite, that could spell problems.”

And there is also the looming spectre of Russia. When Turkey’s military shot down a Russian warplane on its border with Syria in November, the reaction from Moscow was swift and furious. Russian sanctions, imposed from January, included a ban on the import of poultry and fresh produce, and on the sale of Turkish charter holidays to Russians.

Truth be told, most of Moscow’s sanctions lack real bite. But Turkish hoteliers are preparing for a sharp drop in trade this summer, as Russian tourists opt to holiday closer to home, or in faraway India and Sri Lanka. The EBRD’s Markovic said that if fully applied throughout the year, Russian sanctions “will shave 0.3 to 0.7 percentage points off Turkish GDP” in 2016.

Stroz Friedberg’s Tuncalp said sanctions will further undermine a vital sector already reeling from heightened security risks at home. “Economists forecast that tourism revenue will tumble by a quarter this year,” he said. “Russian sanctions will cost between US$2.3bn and US$8.3bn in 2016.”

But to Societe Generale’s Hulea, a newly discordant relationship with Moscow “has been counterbalanced by resilient EU export demand and still-subdued oil prices. I expect both the frozen relationship with Russia and broad security concerns reflected by international media to bite hardest on the external balance on services”.

Reform required

Seasoned observers will also keep their eyes peeled for signs that, after years of foot-dragging, Ankara is prepared to rediscover its once-impressive reformist credentials.

“With the election uncertainty of the past few years now out of the way, it’s essential that the government push forward with measures to boost labour market flexibility,” said the EBRD’s Markovic.

Other reforms in the offing include drives to deepen the country’s capital markets, liberalise the state railway system and inject greater energy efficiency into the economy.

“The period just after elections is an ideal period to implement structural reforms, particularly those that may not be fully popular,” said Markovic. “We had several years of repeated elections (including two general polls in 2015, in June and November), and that kind of environment was not conducive to structural reforms. Now is the right time to do them.”

Here at least, there is a sense of genuine optimism. President Erdogan may well be “viewed increasingly negatively in the West”, said East Capital’s Svedberg. At home, there are more than a few rumblings of discord about the true nature of the president’s long-term ambitions. Is he happy to remain a ribbon-cutting chief executive, or does he yearn to transform his office into a genuine executive presidency, where he is able to hire and fire prime ministers at will?

Either way, few are in doubt about the president’s commitment to reform. During his first six years in office as prime minister, between 2003 and 2009, Erdogan was widely viewed as a bona fide reformist, and many now hope he wants that mantle back.

“Most people are concerned by the [prospects of an Erdgoan-led] executive presidency, in terms of the over-concentration of power and whether this erodes checks and balances and creates policy missteps,” said Nomura’s Ash.

“But he delivered consistent majority governments [as premier] that were good for reform and development. Like him or not, Erdogan has a vision. He wants economic development in Turkey.”