Bridging east and west

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Emerging Markets

Sitting between Europe on one side and the Middle East on the other, Turkey in some ways has its feet in both camps, and in other ways in neither. It has expended much energy in recent years bringing its economy closer to that of Europe. And yet it is to the East where many expect to see the best performing economies of the future.

As geopolitical tensions mount, Turkey increasingly finds itself situated on an important international fault-line, which adds importance – as well as risk – to its position. The country is in a unique position to broker relations between the two sides as, politically and diplomatically, they move ever further apart.

On the financial front, Turkey has been attracting investment from all sides. Among its emerging markets peers it is an attractive proposition. “Turkey has a dynamic corporate sector,” said Mehmet Mazi, head of HSBC’s emerging markets group for EMEA. “It is quicker to react to events than you see in comparable countries like Russia and the Central European states. Turkey is less sensitive to ongoing political tensions.”

Around 70% of Turkey’s equities are held by foreigners, as well as around 30% its bonds. This unusually high level of foreign influence leaves the country exposed as foreigners are more likely to quit the market when times are tough. Investment in Turkey has already dropped off in 2008, relative to the huge flows witnessed in 2007.

Looking west

This also makes European Union accession talks crucial, because foreign investors need to see this process is continuing, even if progress is slow. “If either the EU or Turkey stopped the negotiations it would be a disaster,” said Beat Siegenthaler, chief strategist for emerging markets at TD Securities in London. The very fact this is so well understood by all parties involved means it is very unlikely to be a problem, he added.

The European Union membership process remains an important question hanging over the country. There is much debate about the likelihood of a favourable outcome at the end of it, but Turkey’s government has given outward signs of commitment to the cause by putting in place a predominantly pro-EU cabinet after the last general election. This sends out the right signals to the market.

But there is no doubt Turkey is feeling a little unwelcome at the moment. “The Turkish people are very independent, that is there mentality,” said Andreas Schroeter, head of operations in Turkey for WestLB. “They know Europe is good for their economy so they will continue to implement the reforms but I wonder whether they will join the EU even if they are invited. They may take the economic benefits but back away from the prospect of greater political integration.”

In some ways, however, this is irrelevant, as many Turkish bankers and observers attest. “The journey is more important than the destination,” when it comes to EU accession talks, said Caroline von Nathusius, an associate at Linklaters. The process is helping Turkey stay on the right path with its inflation, interest and GDP growth targets, all of which help attract FDI.

“I don’t care whether Turkey eventually joins the EU or not, as long as it continues to implement the reforms it would need were it to join,” agreed Siegenthaler. But the talks remain important as visible proof to investors that the country is committed to continuing the reforms. Many investors don’t have the trust in Turkey yet to free it to move forward without the EU talks as an anchor, Siegenthaler said.

In terms of implementing the kinds of reforms necessary to pave the way for EU membership in the future, Turkey is progressing nicely. Since 1999 Turkey has recognised the legitimacy of international arbitration in disputes involving contracts for public services with a foreign element. The FDI Law of 2003 and International arbitration Law of 2001 have further created a level playing field for international investors.

The enforceability of contracts in Turkey, one of the factors that potential investors look at, is also good. Recently it enacted a new Insurance Law and made moves to liberalise its telecoms sector, for example allowing number portability, which will effectively open it up to greater competition. Foreign ownership rules in the media are rumoured to be on the verge of being relaxed.

Various other aspects of Turkish policy need to be addressed in order to keep the international institutions happy: the EU has been pushing for change in article 301 of its constitution, which makes it a criminal offence to insult Turkishness.

Yet the road to the EU looks to be effectively blocked by Turkey’s inability to recognise Cyprus, said Seher Fazlioglu, economist at Global Menkul Degerler in Istanbul, who believes the reforms will continue to be implemented despite concerns over how the process will ultimately play out. Turkey will gain more from implementing the reforms for their own sake than it would from actually joining Europe, she said.

Looking east

For all the noises the Turkish government is making to maintain strong relations with its European allies, it is to the east that it sees its most natural friends, born of shared religious and cultural beliefs and heritage. The government’s economic shortcomings may yet be concealed by the steady inflow of capital from oil-rich, Islamic neighbours – a fact that some see as conscious policy. “I think the government is hoping Gulf investors will help them out,” Toksoz explained – an eventuality she admitted is not unlikely, although it is unsustainable in the longer term. She estimated Middle Eastern investors can only be relied on to pump investment into the country for two years maximum.

More generally, Turkey’s relationships with its neighbours to the east are better than ever, thanks to its moderate Islamic government. The Gulf has become a source of capital to a greater degree than has been the case in the past. Turkish Telecom has passed into Saudi hands, while a significant amount of Turkish real estate has been bought by Kuwaitis and other Arab investors. “If we had more political stability we would probably see even more,” admitted Fazil Zobu, head of research at Standard Unlu in Istanbul.

There have also notable investments in the financial sector from Gulf countries, including the acquisition of a number of significant interests in Turkish participation banks – Shariah compliant banks that charge no interest.

There are four participation banks in Turkey, three of which are owned or controlled by Arab interests.

Gulf investors are interested in expanding their investment profile in Turkey, said Brett Hailey, a partner at Denton Wilde Sapte, which advised on the takeover of Turkiye Finans by Saudi Arabia’s National Commercial Bank.

Property investment by Arab investors has been even more sizable – all over Turkey, but particularly in Istanbul, Hailey said. Suma Dubai, for example, acquired land previously used as a bus station to erect a residential complex for around US$750m, with the apartments likely to be snapped up by Arab high net-worth individuals.

While the big real estate investments being made in Turkey are good news, they have a limited impact on the country’s broader economy.

To its immediate east, the conflict in Iraq, with which Turkey shares a border, has added to the uncertainty of EU accession talks and the country’s own internal political problems. But as yet this has not spilled over to cause significant material problems in Turkey.

There are signs, however, that an over-reliance on solidarity among Islamic countries could be misplaced. One banker indicated he has been increasingly taking Turkish corporates to the Middle East as part of roadshows, as the region is awash with capital and has appetite for Turkish exposure. But it has not proved a magic wand for Turkish corporates, he said. Kuveyt Turk is a Kuwaiti Turkish bank that, on paper, should have been received with enthusiasm by Arab investors, but its IPO had to be postponed just as many others have. “It proved a deal having a Middle Eastern flavour is not a guarantee it will be done,” the banker said.