Turkey 2005 - Historic opportunity
Getting a date for negotiations to begin on EU membership is one of the main achievements of the current Turkish government. But according to Sedat Aybar, if Prime Minister Recip Tayyip Erdogan wants to really leave his mark on the country, he has to tackle some fundamental political and economic problems.
The trajectory of Turkey’s economic and social change over the next decade was fixed at the EU leaders’ summit on December 17 2004. The decision to start accession negotiations with Turkey in October 2005 marks the beginning of a significant episode in the country’s history.
The genuine prospect of full EU membership, plus the country’s strong economic performance since 2002, has created the sensation that the country has passed the point of no return, and the AK Party government of Prime Minister Recip Tayyip Erdogan claims all the credit for that.
But since December’s news, the sort of dynamism you would expect from a government enthusiastic for a full membership has been lacking. For one thing, the government’s failure to put together the essential ingredients to start a successful negotiation process has begun to strike at the foundations of the AK Party’s own
parliamentary dominance. A number of AKP members of parliament have defected to other political parties, or chosen to become independents. Consequently, premier Erdogan’s ability to amend some of the “inauspicious” clauses in the constitution – particularly in connection with presidential elections due in 2007 – has been undermined, as the resignations have reduced AKP representation in parliament below the two-thirds majority necessary to change the constitution.
Secondly, the AKP government has been criticised by euro-enthusiasts for its slowness in naming its team for the accession negotiations with the EU. For EU enthusiasts, this is an indication of both sloth and fatigue.
Thirdly, the government’s handling of human rights abuses and issues relating to transparency, democracy and ethnic minorities has been inept. One example was its heavy handling of demonstrators during the Women’s Day celebrations on March 8. Additionally, the new Criminal Code, due to be introduced on April 1 was withdrawn abruptly following a salvo of criticism on the clumsiness of some of its clauses.
In terms of external relations, the government has been criticised by the US media for the deterioration of diplomatic relations with the US and Israel, and for provoking anti-Americanism in Turkey. And there has been criticism for its incompetent handling the ongoing Cyprus problem.
In view of these contentious discussions, the changing parliamentary arithmetic and the limited ability of the government to manoeuvre between external forces, show that the AKP government is failing to successfully capitalise on its achievements, and convert them into a more stable political consensus.
Despite its heavy majority in parliament, the AKP appears to drift wearily among these strong political and social forces. There is a sense of “two steps forward, one step back” in the government’s moves between the secularist opposition and the AKP’s Islamist rank-and-file, who are hostile to US military operation in Iraq for example.
Nonetheless there is a sufficiently long time before the next parliamentary elections to allow Tayyip Erdogan to counter some of these criticisms. One area that can salvage government’s popularity is the economy.
At least the economy looks good
Turkey achieved a record GNP growth rate of 9.9 % during 2004, and per capita income increased by US$789 in a year, reaching US$4,172, the highest figure since the foundation of the Republic in 1923. GNP rose from US$241bn in 2003 to US$301.5bn in 2004, and since 2002 (when the AKP came to power) the growth rate has been an average 7.9%. The budget deficit declined to less than 10% of GNP, and public debt is down to around 63.5% of GNP.
The rate of CPI inflation declined from 25.5% in 2003 to 9.3% in 2004, and external trade improved dramatically in 2004. Export revenues reached US$62.7bn and imports increased to US$97.2bn, while Central Bank (CB) foreign currency reserves soared to US$35bn. (See the article on the economy for more.)
In addition, Turkey began 2005 with a new currency that removed six zeroes from the old Turkish lira. The New Turkish Lira (YTL, though in this report we have shortened that to TL) was launched as a result of the confidence that resulted from the steady decline in the rate of inflation and financial and business optimism relating to the prospects for EU membership. (It has also allowed the development of an international TL-denominated bond market – see the article in this report for more.)
But these remarkable achievements are built on highly volatile foundations, and serious tuning of the economy is still pending. For a start, this economic performance has been achieved at a time of favourable foreign currency rates. However, the high growth rate has translated into only a 4% increase in the rate of employment, while unemployment among young people in the cities is around 25%.
Strong domestic demand for imported inputs for manufactured exports is expected to continue in 2006, further increasing import expenditure and leading to a larger external imbalance. The corporate sector has chosen to upgrade its capital stock by importing labour-saving technologies in the presence of the higher Turkish lira. This has increased labour productivity and reduced the wage burden on the corporate sector.
Secondly, economic growth is financed by foreign borrowing by the public and private sectors. The public sector external debt burden increased from US$70bn in 2001 to US$89.2bn in 2004. In total, Turkey’s external debt stock increased by US$50.1bn between 2000 and 2004.
The increase in the stock of external debt is larger than that needed to make up the savings gap, so external debt has grown far more than the amount required for economic growth. This has raised concerns about the make-up of the external debt stock, and the role of capital coming in search of interest rate and currency arbitrage, with the character of hot money. This type of capital is not sustainable in the longer term, and can be highly destabilising.
Thirdly, Turkey has continued to deliver higher real interest rates to foreign investors. Higher real returns providing high arbitrage revenues have led to an increase in short-term capital inflows. The presence of hot money is also destabilising as an abundance of foreign currency leads to appreciation of the domestic currency that encourages imports.
The balance of payments figures
show that residents’ capital outflows, accumulated reserves and the current account deficit have been financed by non-residents’ capital inflows. At the same time, the item “net errors and omissions” has increasingly become an important element in Turkey’s external financing. Although this balancing item does not necessarily mean cross border movements, the surrender of the economy to unrecorded movements of capital does need to be promptly addressed.
Fourthly, domestic demand – largely exhausted – is being supplemented by the expansion of consumer credit, which has benefited from the entrance of foreign banks into the markets. Consumer credit, particularly that based on the use of credit cards, has risen in importance. (See article on the banking sector for more on this.)
The Central Bank, which is locked into targeting price change, is unlikely to give up its short-term, high interest and currency rate policy. But the CB’s monetary policy tools to control money supply are undermined by the fact that foreign banks are allowed to acquire TL liabilities.
Expectations about Turkey’s economic performance will be heavily influenced by the relationship with the IMF. The economic setbacks listed above can be eased once the government has reached a stand-by agreement with the IMF, now due to be signed at the end of April 2005. This agreement will postpone re-payment of US$20bn due to the IMF in 2006 and 2007, and provide Turkey with an additional US$10bn. Such an agreement, when finally signed, will signal that the government is committed to a tight fiscal policy, and thereby lower its borrowing costs.
The IMF stand-by will also force the government to implement unpopular structural reforms in areas ranging from healthcare, through social security to market regulation. And the government is set to continue with its privatisation programme. (See equities article for detail on this.)
However, even if the government implements such policies, there are a number of risk factors. Strong domestic demand on imported inputs for manufactured exports is expected to continue in 2006, further increasing import expenditure and leading to a larger external imbalance.
Turkey’s future economic performance will be affected by various external factors – slower world growth, the abolition of textile quotas, the US growth rate, US dollar strength, the tightening of US interest rates and economic recovery in the EU. And the government’s failure to translate favourable economic performance into job creation, the abysmal level of domestic demand and the importance of balance of payments performance for economic growth, have effectively increased Turkey’s vulnerability to movements in foreign exchange markets.
There are positives. Economic growth is likely to be supported by a decline in nominal interest rates, consumer credit growth, and increased labour productivity in export sectors. It is also likely that currency rates will remain stable during 2006, helping to keep the inflation rate low, and strengthening business confidence.
On the other hand, given the level of the domestic currency and the growing current account deficit, a sharp correction of US$/TL rates is the likely cause of any future economic crisis. Such a sharp exchange rate adjustment might lead to higher interest rates and push the inflation rate higher, leading to a debt crisis. The government’s ability to avoid such a crisis will be conditioned by its capacity to borrow from external markets, which will in turn depend on continuing IMF support.
Turkey hopes that it has reached the point of no return in its progress to EU membership, and the continued buoyancy of the country dictates constant progress towards this objective.
Against that background, in the second half of 2005 it will be crucial for Prime Minister Tayyip Erdogan to attend to the country’s embryonic political and economic crises if he still wants to be in the driving seat. Otherwise, for all his achievements over the past couple of years, his government’s achievements will be remembered as an insignificant phase on Turkey’s long path to the EU.
Sedat Aybar is a lecturer in economics at the School of Oriental and African Studies in the University of London.