Turkey 2005 - Still on track
The Turkish economy continues to satisfy most economists’ wish-lists, with high growth, falling inflation and a primary fiscal surplus. Even the problems – such as a high current account deficit and the lack of a new IMF agreement – don’t seem to be worrying many observers. And if the country can only get through the next couple of years, Turkey will really have broken the mould. Paul Farrow reports.
Ayear ago, when IFR produced its last Turkey supplement, there was a sense of real bemusement among economists. Almost everything was going well in the Turkish economy – high growth, falling inflation, productivity gains, a good primary surplus – but after years of disappointment and a serious crisis in 2001, it was difficult for many analysts to believe it was true.
Twelve months on, many of those suspicions have disappeared. Growth in 2004 surpassed estimates (finally coming in at 8.9%), and in 2005 it is forecast to hit 5% by the IMF and the government.
Inflation has continued to fall, CPI ending 2004 at 9.3%, and is forecast by the government to be at 8% by the end of 2005 – a continuingly strong currency has obviously helped here. Deutsche Bank economist Tevfik Aksoy goes even further, and expects 2005 year-end inflation of 7%. And in an important break with the past, thanks to the single-digit inflation, indexation has almost ended
Cem Akyurek, head of economic research at local brokers Global Securities, is fulsome in his praise for the government’s achievement in areas such as the primary budget surplus. A year ago, Akyurek argued that the economy had recovered from the crisis, but still needed to demonstrate capacity for more normal growth. “Well it’s done that,” he said.
And for the moment Turkey is even managing to defy economic logic. For example, exports have continued to do well despite the continuing currency appreciation. The country has been helped in this area by the fact that it tends to buy in US dollars and export in euros, and the TL has appreciated by much more against the dollar than the euro, notes Murat Gulkan, managing partner at local broker Bender Securities.
However, faced by this happy picture, there are still some analysts keen to inject a note of caution. So what are the weaknesses?
Unemployment remains high (at over 14% in urban areas, but higher still among young urban people). Despite the impressive growth of recent years, Turkish companies have made big strides in productivity (which has risen by 9% a year since the crisis of 2001), so this growth has not fed through into lower unemployment. Unit labour costs have fallen by about 30% since the crisis. The appreciation of the Turkish currency has accentuated the productivity drive, as exporters and their suppliers have struggled to compensate for the stronger lira.
The government’s response has been to increase the minimum wage and to build up regional investment funds. Originally introduced for low GDP per capita regions, these latter measures – including positive tax treatment for new workers and new firms – will now be extended in scope to cover about 50% of regions and existing firms as well.
The IMF has warned about the impact of the regional development scheme on the budget, and wants it to be compensated with lower spending in some areas, and adequately resourced. Some independent economists are also unimpressed.
“Why not cut regulation and taxes rather than introducing this sort of distortion into the economy?” asks Global’s Akyurek.
But the government is keen to head off potential discontent among those yet to benefit from Turkey’s recent economic success. Sedat Aybar, a lecturer in economics at the University of London’s School of Oriental and African Studies (and author of the first article in this report), believes that labour unrest is likely as a result of the failure of real wages to rise.
“The trade union movement in Turkey is historically weak, but there are signs of the various unions – Islamic, left and right-wing – making common cause,” he said.
Among economists’ other concerns, the most regularly mentioned is the continuing high current account deficit, which is running at 5% of GDP, and financed by short-term capital flows. A restatement of historic numbers to reflect the black economy will reduce the percentage ratio to GDP, but the problem will remain.
Lehman Brothers economist Tolga Ediz has no confidence that the solution to this problem will come from higher foreign direct investment. “There doesn’t seem to be much scope to get annual FDI above US$5bn, which just isn’t enough,” he said.
However, at least in the short term, economists are sanguine about the threat posed by the current account. “Banks have small short positions, and companies indulging in foreign borrowing are not that dependent on TL revenues,” said Global’s Akyurek.
As a result, few observers expect a major currency crisis, despite the lira’s overvaluation. Instead, Mina Toksoz, a country risk analyst at Standard Bank, forecasts some depreciation on a 12-month view, which is in line with the government’s view.
Another issue, although one to which the markets currently seem to give little importance, is the absence of a new agreement with the IMF – the delay now runs to four months. There seems little doubt among analysts that there will ultimately be a new agreement, probably amounting to US$10bn over three years.
Standard Bank’s Toksoz says that there is no obvious tension with the Fund, but given the importance of the Fund as a guarantor of good behaviour from Turkish governments in recent years, the market’s lack of concern about the current absence of an agreement is striking, and perhaps the best evidence that investors have become overly optimistic.
The IMF has called for a number of technical, but important, reforms in the fields of social security (pension reform), tax (to make tax inspectors more independent) and the banking sector. These have to be finalised in a way that meets the IMF’s requirements. Global Securities’ Akyurek believes that the government has shown some complacency in this area. Social security reform, for example, is very important for long-term fiscal discipline, as payments currently account for 5% of GDP.
“Draft legislation that is acceptable to the IMF though not exactly ambitious, has been on the table since July, but the government has had a problem with doing anything on this issue,” he said, speaking in mid March. “The important thing is to strengthen institutions to continue ‘good’ economic policies and sustainable growth.”
Marcel Cassard, head of global macro research at Deutsche Bank, agrees. “Structural reform is not moving as quickly as we would like,” he said. “The problem is that there is some complacency from the government, but markets have, for the moment, lost their interest in disciplining governments.”
In recent months, Turkish securities have been boosted by the powerful combination of positive developments at home and a favourable environment in emerging markets generally that has pushed foreign involvement across several asset classes to new highs.
By asset class, Deutsche Bank economist Tevfik Aksoy estimates that foreign investors are currently neutral to underweight in their holdings of external debt, slightly overweight domestic debt, and overweight on equities.
“The figure for foreign participation in equities is up to 60% of the free float, though that includes offshore Turkish money,” he said.
The recent focus on investment in local markets has certainly helped Turkey on the short-term flow front, but on the other hand, Aksoy points out that any reaction against emerging markets generally would hurt Turkey badly. “This is still a high-beta country,” he said.
The most likely source of immediate threats to the current positive scenario is certainly external, in the form of higher oil prices or a sharp rise in US interest rates, which would also have the effect of dollar appreciation.
Deutsche Bank’s Cassard thinks that valuations had become stretched in many emerging markets, including Turkey. He changed his recommendation on Turkish debt to underweight in mid March.
“A lot of good news is behind us. A withdrawal of liquidity would have negative effects,” said Cassard, who sees Brazil and Turkey as among the emerging markets vulnerable to an abrupt rise in US interest rates.
And Lehman’s Ediz also sounds a warning note about the state of the markets. “We were more bullish before,” he said. “The reason for the current confidence is inflows, foreigners buying. That has left the markets looking overstretched, but there is no obvious short-term catalyst for a change in market direction."
In the event of a sell-off, Deutsche’s Cassard believes local currency bonds would outperform external debt, given the high percentage of local investors, the strong growth and high interest rates. But he cautions that in an abrupt sell-off, Turkish local debt securities would be hit as well.
Overall, however, there is a sense that the country is on the right track economically, and that if Turkey can weather the next couple of years, it will be in a very different situation.
“The wind is in our favour, the wind being global liquidity,” said Riza Kutlusoy, head of capital markets at Is Bank. “So long as the situation continues positive to mid 2007, Turkey will be OK. And once the country gets to BBB– [investment grade] a new pool of investor liquidity will open up.”