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Sunday, 22 October 2017

Unready! Unsteady! Go?

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Turkey is failing to make the most of lower oil prices. With growth slowing, inflation rising and unemployment making a comeback, investors are beginning to fret.

Turkey’s economy should be steaming ahead. Many of the key ingredients for success are there: a dynamic, entrepreneurial and relatively young population; solid, well-run banks; low labour costs. The nation’s finances are reasonably strong, thanks to low government debt as a share of economic output (45.1% in 2013, down from 46.9% the previous year, according to the World Bank), and a strong export base.

Even oil prices, once the bane of budget officials, have come to Turkey’s aid, tumbling helpfully in late 2014 and remaining reasonably low.

Turkey still offers investors a “large and growing market, consistent policy-making in favour of large investments, offering good conditions for foreign and local investors, and good access through banks to capital funding”, said Jean-Patrick Marquet, director, Turkey, at the European Bank for Reconstruction and Development.

Gyorgy Kovacs chief economist, emerging EMEA at UBS, said it remained a “strong economy backed by prudent fiscal policy, a good banking system, an entrepreneurial society and positive demographics”.

Yet somehow, that isn’t enough. The world’s 18th largest economy is becalmed and rudderless, lacking impetus or direction. In its latest World Economic Outlook, published in April, the IMF tipped economic growth to reach 3.1% in 2015 and 3.6% in 2016, up from 2.9% last year.

Others see that as unreasonably optimistic. Growth dipped to 2.6% in the final three months of 2014, and Gabor Ambrus, emerging markets analyst at RBS markets and international banking, said Turkey would “be lucky to grow at even half that rate in the first quarter of 2015”.

The government’s much trumpeted 5-5-5 plan (targeting a 5% budget deficit, and the same percentage rate of both growth and inflation) has been quietly shelved. Consumer prices rose 7.61% year-on-year in March, up from 7.55% the previous month. Marcus Svedberg, chief economist at emerging market investment manager East Capital, scratches his head over the dilemma facing politicians in Ankara.

“Turkey [should] benefit a lot from the lower oil price, as growth gets a boost while inflationary pressure falls and the current account deficit shrinks,” he said, yet, “the economy has not yet responded to these underlying factors, with growth remaining on the weak side and inflation sticky.”

Lira worries

Of graver concern is the lira, which hit a record low against the US dollar on April 15, on fears of rising jobless rates and a widening budget deficit, which grew to TL6.8bn (US$2.5bn) in March. In the year to April 23, the lira weakened by almost 15% against the dollar, making it the world’s worst performing major emerging market currency this year.

Compare that with Russia, whose currency, while still on the mend, has made a Lazarus-like recovery from its December lows, or the relatively marginal declines in most currencies across Central and South-Eastern Europe. The lira’s travails are only likely to worsen as the US Fed prepares to move to a tighter monetary policy.

Turkey’s problems are layered and complex. Analysts have their own take on the suddenly enfeebled economy. Timothy Ash, head of emerging market research at Standard Bank, said the “core concern over the past four years has been a marked slowing in the pace of reform”.

Many see the lack of structural economic change as indicative of the turmoil renting the fabric of government. Guillaume Tresca, senior emerging market strategist at Credit Agricole, said reforms had stalled in large part due to “growing tensions within the AKP”.

A series of rapid-fire elections in recent years, each seen as a de facto referendum on both the AKP Party and President Recep Tayyip Erdogan, have diverted attention, also “slowing substantially the pace of reform”, said Tresca.

Sporadic internecine warfare fought between a distrustful government and a battle-weary central bank has hardly helped.

The decision to cut the overnight lending rate by 50bp in February, to 10.75%, was widely seen as a defeat for the Central Bank of Turkey. Its decision came after weeks of vicious, hectoring demands for lower rates from Erdogan and his allies, who criticised the central bank for stymieing economic growth.

Yet the capitulation merely “fuelled concerns about the independence of the central bank and its efficiency”, said Tresca.

On the road to nowhere?

Then there’s perhaps the real elephant in the room: the country’s increasing lack of economic and political direction. These issues are two sides of the same coin and, as is so often the case in modern Turkey, their resolution is tied to the fate of Erdogan.

Turkey’s 12th president faces an uncertain future. Popularly elected to the post last year, the assumption was that the AKP would win upcoming parliamentary elections in June with room to spare, possibly with a handy two-thirds majority.

Having accomplished that, Erdogan’s party would push through immediate constitutional changes, handing the president a raft of new powers.

This now seems unlikely. The AKP is unlikely to secure the 367 seats required to change the constitution without a referendum. That would leave the president in an awkward and emasculated position: a man accustomed to wielding power, yet reduced to the role of cutting ribbons rather than writing laws.

Unable to plan for the future, many say the government has begun to drift.

“The key question at the moment is who, at the moment, is actually in charge of the country,” said RBS’s Ambrus. “We are potentially headed to a constitutional crisis, as we have a prime minister and a president, yet the separation of powers between the two is not entirely clear. It would be good to know who is actually managing the economy.”

Many still say Erdogan is still quietly pulling the strings behind the scenes. Even if this is true, this is no way to run a country, and investors have long since realised that Turkey, for all of its huge potential, is an economy in limbo.

“For local and foreign investors, there is a problem of perception here,” said Ambrus. “The government and the president say they are co-operating and that everything is fine. But below the surface things don’t look smooth at all. The lira has fallen in value against the dollar every month since the start of the year, and that’s a reflection of this uncertainty.”

Three final challenges to the nation’s economic equilibrium remain, each troubling. The first is credit. High consumption rates have helped the economy through some pretty lean times in recent years. Yet that can’t and won’t last forever.

“Turkey is a big problem, and it’s facing some big problems,” said Jonathan Anderson, a partner at Hong Kong-based consultancy Emerging Advisors Group.

“Economic problems, including a steeply rising unemployment rate, drove the AKP to power and then falling unemployment helped to consolidate their power. Now, a weak economy and rising jobless rates is undermining their power”

“It’s burdened by a huge deficit and the economy is currently being funded by a huge credit binge, thanks to banks borrowing short abroad. At some point, Turkey is going to face a very vicious capital turnaround story. There are few other countries in the emerging world currently hobbled by that set of problems.”

Bojan Markovic, lead economist for Turkey at the European Bank for Reconstruction and Development, noted that while the country’s credit-to-GDP ratio is running at around 70% – in line with international norms – that number is up 30 percentage points in five years, and continues to rise. “Policy-makers,” he said, “need to remain vigilant” about credit.

“What matters most is quality not quantity. It’s imperative that credit spills into the hands of efficient corporates more competitive globally and able to drive sustainable growth in the years to come.”

A second concerns the wider region. Turkey’s economy may be just about in the black, but its main export markets are still beset by structural weakness, from the eurozone to sanction-hit Russia to the transition economies of North Africa and the Middle East. These will remain factors “limiting Turkey’s growth and ambition over the next two years”, said Markovic.

The final fly in the ointment is unemployment. Erdogan and the AKP Party rose to power in 2002 on a jobs ticket. They pledged to get people back to work and, thanks to internal reforms and a benevolent external environment, they succeeded.

But unemployment is rising again, tipped by the IMF to reach 11.4% by the end of the year, up from 9.9% in 2014 and the highest rate in more than five years. Even that number might be soft: data from the Turkish Statistics Institute show the jobless rate hitting 11.3% in January, up 0.4 percentage points from the previous month.

This puts the AKP in a tricky position ahead of elections. And things may yet get worse.

“Economic problems, including a steeply rising unemployment rate, drove the AKP to power and then falling unemployment helped to consolidate their power,” said RBS’s Ambrus. “Now, a weak economy and rising jobless rates is undermining their power.”

Many say those factors help to explain the government’s attack on the central bank and civil society, the president’s power grab, and the temporary closure of social media accounts.

Said a leading emerging market investor, on condition of anonymity: “It’s because the AKP is trying to maintain their grip on power, as they know that grip is slowly but surely slipping from them.”

 

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To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com

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