Don’t count your airports…

IFR Emerging Europe and Turkey Special Report 2014
8 min read

Corruption allegations and political instability have alienated investors in Turkey’s ambitious construction projects, many of which are now set to remain at ground level.

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Istanbul has set its heart on building one of the world’s busiest airports among other high-profile projects but with international financing becoming harder to secure and investors’ faith bruised by political instability Turkey’s ambitious construction projects may be slower to get off the ground.

Turkey’s outlook has been rosy in recent years thanks to a fast-growing economy, a government with a long-term vision and mounting interest from private investors, keen to take advantage of the country’s high growth rates.

Wedged between Europe and the Middle East, Turkey is aiming to capitalise on its strategic location by becoming a major regional transport hub that boasts high-speed rail lines, motorways and a “super” port, all on its way to becoming the world’s 10th-largest economy by 2023.

Then disaster struck: a controversial corruption probe – which implicated members of Prime Minister Recep Tayyip Erdogan’s inner circle – alongside increasing political instability in the wake of the Gezi park protests, has alienated investors. Furthermore, global interest rates are set to rise, squeezing Turkey’s desirability on the international scene.

HSBC’s global head of infrastructure, Arturo Recio, told audiences at a British Business Summit in Istanbul in April that new Basel III rules on bank lending could affect international long-term funding availability for project financing in many markets, including a number of projects in Turkey.

An oversupply of projects, in transport, healthcare and energy, also needed to be curbed in light of the new global conditions, and as Recio says, governments around the world would need to prioritise projects.

Sky’s the limit

Turkey seems determined to push ahead with its grand designs, several of which have been championed by the Prime Minister. The government even pledged to guarantee the debt of contractors on public works projects in April, with state guarantees previously limited in the wake of a fiscal crisis in 2001.

“Overall, progress is definitely going to slow down a bit, given the external and internal developments,” said Istanbul-based Huseyin Ozhan, senior banker at the European Bank for Reconstruction and Development, which since 2009 has invested €3.5bn in 119 projects in Turkey, including the Eurasia Tunnel.

“But I think there will be some activity in the market, even with the mega projects,” he added.

For public-private partnership projects, the private sector is waiting to see more certainty, in particular the outcome of the presidential election this summer as well as the availability of financing.

“Regarding the state funded projects, high-speed railways, etc, those are continuing as budgeted, without any delays,” Ozhan said.

Ports and airport projects are being touted as the big areas of growth in Turkey’s infrastructure story, as sea routes gain share and trade links with the EU expand.

But projects such as Istanbul’s third airport, which Turkey hopes will become one of the world’s largest in terms of passenger numbers, eventually greeting 150m passengers a year, is under close scrutiny, especially against the global backdrop of rising interest rates and high construction costs.

The 25-year tender was auctioned off for a record-breaking €22bn last year to a consortium of Turkish construction firms, but fears persist that Turkish banks lack the capacity to provide long-term large-scale funding without international help.

In a bid to provide cheaper financing for some projects, the government is pledging to insure 85% of the price of projects costing over TL1bn should an agreement fall through because of the contractor’s fault. The Treasury will assume at most US$3bn for public works project debts for 2014.

Nurol Holdings, which is leading the Gebze–Izmir motorway project that will include a 3km suspension bridge, signed a US$600m loan agreement with eight banks for a section of the road in the first quarter of 2014 and said it was expecting to negotiate a debt assumption agreement with the Turkish Treasury imminently.

But the return to state guarantees has stoked concerns over public finances and fears of ballooning public debt.

“The danger, though, is that if it reverses the trend, improvement in public finances/debt ratios could threaten the sovereign credit rating, and increase the overall cost of sovereign financing as a result,” said Timothy Ash, head of emerging markets strategy at Standard Bank.

“But despite the tricky domestic politics/investment environment, Turkey still has a lowly public sector debt/GDP ratio of 37%, still in decline, and a stellar track record of paying… I also still tend to think that 2014 will be a year of rebalancing,” said Ash.

New sources

With the global financial sector at a limited capacity to finance projects, Turkey must tap new sources of capital to meet its ambitious targets, said experts.

Mersin International Port listed Turkey’s first-ever infrastructure bond on the Irish Stock Exchange last year, signalling a new blueprint for other infrastructure assets. Turkey’s port operator, a joint venture between Turkey’s Akfen Holding and Singapore’s PSA International, issued US$450m in bonds on the Irish Stock Exchange.

“This was a good example for infrastructure companies tapping into the capital markets rather than classical project finance or corporate finance,” said EBRD’s Ozhan, adding that the model was likely to be replicated again. “The biggest structural change will be to see some of the companies tapping into the capital markets. I think we will be able to see one more deal [like Mersin’s] this year,” he added.

Pension funds, sovereign funds and Islamic financing must also be on Turkey’s radar.

“We have to be more creative; besides the large seven or nine financing banks in Turkey, we need to attract infrastructure funds and global pension funds,” said Deloitte M&A advisory head, Mehmet Sami, noting as well the importance of using more public-private models in Turkey.

However, tapping innovative sources of capital can present challenges. Kerim Kemahli, CFO of Nurol Holdings, said that putting together a transaction with so many different types of banks, ranging from Islamic to ECAs, from local Turkish banks to IFIs, could be time-consuming.

“Fast execution of project finance can in some instances be a more important factor than the margins on the loan,” he said.

Other big infrastructure projects in Turkey have hit roadblocks. The country’s first nuclear power station is likely to be delayed by at least a year, amid environmental concerns. Istanbul lost its bid to host the 2020 Olympics last year, the planned centrepiece of a US$19bn infrastructure budget for the city, while the business case and appetite for Erdogan’s plan for a new canal to bypass the Bosphorus is weak.

But the long-term infrastructure needs of Turkey are irrefutable, and projects must go ahead.

“Like many other more mature companies, Turkey has to rethink and shift its infrastructure in many ways. For example, in power, emphasis on gas and thermal power plants is not going to be the future,” said London-based Tatha Ghose, senior emerging markets economist at Commerzbank.

“This kind of ‘frictional’ investment requirement, which arises because the pattern of investment in past decades proves less suitable given how the the economy is evolving now [in other words, the growth model has shifted], warrants a fresh burst of investment,” he added, noting a similar situation in China and India.