Taking the next step
In an exclusive interview with IFR, Mehmet Simsek, Turkey’s Finance Minister, talks frankly about the issues his country faces.
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Despite an economic growth rate that most EU members would envy, Turkey finds itself at a crossroads. In 2010 its GDP grew by 9% with 2011 estimates from the World Bank at 6.1%. Compared with forecasts of as little as 1.9% for the eurozone in 2011, it’s not hard to imagine why the Turkish government might be experiencing a sliver of schadenfreude.
But beneath the growth lie some inconvenient truths. The unemployment rate is at a stubborn 8.2%. The primary equity and bond markets are quiet and growth from the EU, its largest trading partner which receives almost 50% of Turkey’s exports, could be sluggish for years. Perhaps worst of all is its current account deficit which remains stuck at a worrying monthly US$6bn.
As such, the country’s iPad-wielding Finance Minister Mehmet Simsek is anything but complacent. He is perfectly frank about the issues his country faces and succinctly answers questions about his plans for Turkey’s nascent financial industry and tackling the deficit. He is upbeat but realistic, and says Turkey still has every intention of joining the EU and its currency.
“Our focus right now is on increasing savings in Turkey in general and also in making Istanbul a regional financial centre. In the first half of this year we plan to submit a draft bill to achieve these objectives.” he said in his office with sweeping views of Ankara, adorned by Turkish and EU flags and a photo of Prime Minister Recep Tayyip Erdogan. “We have a healthy and sound banking sector and reformed it during the last decade. It’s reasonably well regulated and supervised. We are encouraging Turkish companies to get listed on the stock exchange and increase investment options available to investors.”
The focus on savings is connected to a push to get more Turks enrolled in private pensions, with the calculation that this will lead to more interest in equities and other longer-term savings products. Simsek explains that many Turks still have savings in gold or even keep their savings in vaults at home. Figures showing gross savings declining as a percentage of GDP worry him, and he believes that this is part of the reason why Turkey’s equities market has been so flat. Last year there were only three IPOs, and there have been none since May 2011. This represents a sharp drop off from 2010’s record 23 IPOs.
Simsek certainly wants to see improvement in the equity market, and highlights an initiative by the capital markets board and the Istanbul Stock Exchange to get more companies listed, particularly SMEs. The initiative will make it easier to list as traditionally Turkish firms, which are usually family controlled, have shied away. Furthermore a new commercial business code says firms have to be transparent and follow certain standards whether they are listed or not.
“Our focus right now is on increasing savings in Turkey in general and also in making Istanbul a regional financial centre”
“In the past companies didn’t see why they should get listed,” he said. “They had access to capital from banks. They didn’t have to come up with financial statements that were at par with international standards or have independent board members or things like that. The new code changes that, so I think there will be an incentive from companies to get listed.”
However, he points out that the main problem in getting companies to list is a matter of demand, as the domestic investor base is narrow. Simsek sees foreign investors filling part of this gap, but returns to the drive to get more Turks enrolled into private pensions as a factor that would boost domestic interest in equities. He cites Poland as an example of where this happened.
On the fixed income side, growth has been similarly sluggish, and the much-talked about push into Islamic issuance has stalled. There have been only two international sukuk deals from Turkey, partly, Simsek says, because much global issuance in that market is driven by government financing needs and demand.
“The treasury has yet to tap the sukuk market,” he said. ”So far non-interest banking has done a couple of issues. Needless to say, if and when the treasury gets involved, the market is likely to pick up.”
Turkey’s financial industry certainly leans towards a more conservative approach, with few structured or more exotic products on offer and a capital adequacy ratio requirement for banks of 12% that is far more than the Basel III requirements of 8%. Simsek, who holds joint Turkish and UK citizenship and spent several years in London as an emerging markets economist and strategist at Merrill Lynch in the boom years of the 1990s, describes his time in the UK capital as formative and one that shaped his views on how financial markets should be regulated.
He mentions that the Turkish government was running stress tests in 2006 and that when mortgages were introduced to the country, lending restrictions were far tougher than many developed markets. The lessons he learned from the financial crisis are that some structured products can help the market operate more efficiently and would serve Turkey well, but that the most important factor is risk management and governance. He believes that few people truly understood the nature of many of the products they sold, whereas in Turkey a simpler and more regimented approach helped them survive the financial crisis in relatively good shape.
“Turkish banks are well-capitalised and are highly profitable,” he said. “The sector’s ROE has averaged to about 20% over the past five years. The system’s capital adequacy ratio is about 16%, twice what is required by Basel II.”
Yet beneath the good news is the monthly US$6bn dollar albatross of the country’s current account deficit. Despite years of solid growth and economic development, the CAD has not declined to the extent that many analysts had expected. One even went so far as to say that Turkey was effectively run like a hedge fund relying on foreign direct investment to finance its deficit. Even though this is somewhat of an exaggeration, it is undeniable that Turkey is highly dependent on FDI and has been a huge recipient of it in recent years. According to state figures it received US$15.9bn in 2011. Perhaps this system works, but FDI flows are highly cyclical. In 2008, during the peak of the financial crisis, FDI into Turkey fell more than 50% to US$8.4bn.
“Turkish banks are well-capitalised and are highly profitable”
Simsek details a multifaceted approach that he says will tackle the problem in the long, medium and short terms. He blames high levels of domestic demand in both 2010 and 2011 as one of the key reasons why CAD levels deteriorated, and points out that domestic demand last year was growing almost 10 times faster than in the eurozone. In the short term he says they will try to moderate domestic demand through a tighter fiscal policy. This he believes is already happening and points to lower GDP levels as evidence that the economy is reaching a more sustainable level of growth.
There is also an investment incentive regime being worked on aimed at narrowing the developmental gap between regions and improving Turkey’s external balance. This will be done by identifying sectors where more than 40% of domestic consumption is through imports, and in turn offering Turkish companies that produce goods in these sectors various incentives such as reduced corporate tax rates, social security breaks or possibly even the provision of land to build factories. Incentives will be especially abundant in Turkey’s less developed areas, particularly in the east. Simsek hopes that this will enable those regions to compete with South-East Asia in terms of the cost of doing business. These plans have yet to be set into stone, but he hopes to have something finished before the end of the year.
However, the most important long-term move will probably be efforts to diversify away from its dependence on hydrocarbons, which he says is the main culprit for the continued high CAD figure. Last year the country imported over US$54bn worth of energy. In 2002, this figure was only US$9bn, proof of how expensive ever higher oil prices are for Turkey.
“Of course in the short term there is no quick fix, but there is a very strong focus right now in this country on hydro power plants, on wind plants, on nuclear, which we don’t have right now but we’re working on bringing on board, and also on solar energy when it becomes affordable and practical,” he said. “Bottom line is we have a fairly comprehensive strategy at containing and then moderating the CAD. We’re not saying CAD isn’t a big deal. It is a big deal. That’s why we have this strategy.”