Turkey's Next Economic Horizon: reviewing financial indicators

At the beginning of this past week, the world was gripped by the imminent possibility of global financial Armageddon. While the global markets have encountered and overcome small patches of turmoil over the last eight months, only this most recent turn of events has caused the Turkish media, government and upper-classes to immerse themselves in an open round of soul searching. What was once a whisper or secondary thought is gradually becoming the palpable hum of financial anxiety - a reality with which Turkey is extremely familiar.

Over the past few years, Turkey has emerged as one of the global stars of foreign direct investment (FDI). The Turkish lira has reached unprecedented levels of strength, allowing Turks to better cope with rising energy prices, experience unprecedented buying power in the form of cheap goods from China and for wealthier Turks, it has given them more confidence to purchase foreign delicacies such as sunglasses from Gucci. Whether one is a bus driver in Malatya or a bank employee in Izmir, Atatürk's famous saying Ne Mutlu Türküm Diyene (How happy is he who says "I am a Turk") has acquired a new meaning for today's Turkish consumer.

Turkey's AKP-led government continues to maintain a very confident demeanor. The World Bank released a very favorable review of Turkey's GDP prospects in 2008 and investors still show interest despite the looming global financial turmoil. While this observer does not mean to suggest that Turkey's economy will abruptly dive into utter chaos as a result of a global economic downturn, it is important to remember that multiple years of robust growth have produced a lot of fat, which a downturn will ruthlessly trim away. It is only after this inefficient excess has been exposed and removed, that one can truly evaluate the AKP-administered economic renaissance in Turkey.

The following are a number of noteworthy Turkish financial statistics and remarks for consideration. Many of the initial comments were taken from this TDN article.

Year-to-date current account deficit: Rises by 11.6% to $32.758bn in November 2007. The figures for the January-October period were adjusted from $29.06bn to $29.48bn.

12-month trailing current account deficit: Rises to $35.74bn in November from $35.16bn in October 2007 according to Türkiye Ekonomi Bankası (TEB).

Sertan Kargın, chief economist at TEB, said, “We are not concerned about the current account deficit thanks to robust Foreign Direct Investment (FDI) stock, record high foreign exchange reserves, and solid non-debt creating capital inflows.”

TEB key factors driving the current account deficit: “The widening trade gap was mainly due to higher import substitution in intermediate goods, the overvaluation of the Turkish lira, record high oil and commodity prices, private sector capital investments, and the spillover impact of fiscal loosening on domestic demand.”

Global slowdown according to Kargin of TEB: Global growth conditions are the key risk for Turkey’s current account outlook, according to Kargın. "In our view, a consumption-led global slowdown is creating a risk on the current account balance as Turkey’s foreign demand sensitive export industries account for 60% of total exports," Kargın said. "Furthermore, exports are highly sensitive to foreign demand rather than the exchange rate."

FDI in 2006: Almost $20bn in FDI in 2006.

Projected FDI for 2008:
Kargın of TEB: “In 2008, we expect Turkey to raise an additional $20bn to $25bn through FDI, and $4bn to $5bn via global investors’ equity and Turkish lira debt instrument purchases.”

Özgür Altuğ, chief economist, Raymond James, Istanbul: Turkey will probably get $23bn of FDI in 2008. That will finance less than half of a current account gap that’s likely to swell to more than $50bn.

Government Assets and FDI: The recipient of almost two-thirds of foreign investment will likely be the sale of government assets, such as banks, power generation and distribution companies according to Altuğ.

It has also been reported in recent months that the government is trying to accelerate the pace of privatizations.

Sovereign Wealth Funds and FDI: "In the wake of these developments, Economy Minister Mehmet Şimşek traveled to Dubai yesterday to encourage the Saudi Arabia Public Investment Fund and other sovereign wealth funds to increase their investments in Turkey." (For more, please click here.)

"Government officials had previously said Turkey could attract around $10bn in investment from the Gulf countries, excluding the new Saudi Arabia Public Investment Fund, to the real estate, tourism and financial sectors as well as to privatizations." (For more, please click here.)

TUSIAD Remarks: According to the chairwoman of Turkish Industrialists and Businessmen's Association (TUSIAD), Arzuhan Dogan Yalcindag:

“Our growth has slowed down to a large extent and inflation has a relatively upward trend,” she said during an address to a TUSIAD general assembly meeting in Istanbul. “The unemployment rate has begun to increase with high current deficit figures and damaged financial discipline. And unfortunately that is how we are bracing for the upcoming global wave.”

“The world is closing in to a global crisis and 2008 will be a difficult year for Turkey. We need to concentrate all of our energy to economy.” (For more, please click here)

Perhaps the most remarkable issue to emerge from this small assembly of viewpoints is the degree of urgency and weight shouldered by FDI regarding the stability of Turkey's economy in 2008. Turkey needs FDI in order to address its great imbalances in trade. The fact that a government official is openly lobbying for a greater share of the petrodollar FDI pie is rather telling. It also confirms the degree to which the AKP's economic success has been linked to their close ties with the more religiously conservative, petroleum-rich countries. (For further analysis of this political development, please click here.)

Another point worth considering is the two-thirds figure for the amount of total FDI directed towards the sale of state-assets. It is probably quite normal for an emerging market economy like Turkey to attract the majority of FDI in this matter. However, at some point the number of state companies available for auction will dwindle. Ideally, the newly-privatized and traditionally private firms will generate enough new growth to create the market enthusiasm necessary to attract sufficient levels of FDI. However, the transition for state-asset oriented FDI to ultimately represent the minority of overall FDI in Turkey,
instead of the majority, could prove quite difficult in the near term. This will be especially true if the global economy stumbles in the next couple of years and investors decide to retreat to economies with less risk. No wonder Turkey is so keen to attract a portion of the more than $1trn on the table for Saudi Arabia's new sovereign wealth fund.


Further Reading: Earthquake - Istanbul

The following article outlines a study conducted by engineers at Purdue University, who have considered possible solutions to Istanbul's considerable susceptibility to earthquakes. Their motivation to consider this an issue emerges from the following sobering reality:
Istanbul, which lies just north of the North Anatolian fault, is at high risk for a major earthquake within the next 30 years."All of the seismic and historical evidence says a major earthquake is overdue," says Sozen, who led an international effort in 2005 to evaluate the risk of such a catastrophe.That group concluded that it is likely an earthquake with a magnitude of 6.8 to 7.5 on the Richter scale would occur within the next three decades.
Turkey has been hit by earthquakes before. In the modern period of dense urbanization, they have resulted in terrible human loss very often due to the inadequate engineering of buildings and infrastructure. It is doubtful that Turkey will undertake the construction of a satellite city, as suggested by the Purdue engineers, in order to "run away from the earthquake" or any other such substantial preparatory measure in the future. From a financial standpoint, Turkey is neither California nor Japan. It cannot afford the premium necessary to build or reinforce in preparation for even an inevitable natural catastrophe except in the case of a few strategic and monumental structures such as the Bosphorus bridges in Istanbul.

Turkish governmental institutions do not offer the best resume of management skills when it comes to such issues of planning. If the municipal governments in Ankara, Istanbul and Izmir are barely capable of dealing with inadequate water supplies in their city's reservoir systems, how can they be expected to either afford or organize for a problem of much greater complexity and severity? One cannot prepare for an earthquake simply by making frequent, unannounced water cuts. Assuming that the state is unable of play its role, this observer hopes that it will attempt to increasingly inform and encourage the citizens of Istanbul to prepare to the best of their own abilities.


"Made in Turkey" - but for how long?

During a flight from Istanbul to Europe, this observer had the great fortune to strike up a conversation with a gentleman named Mehmet. Mehmet and his wife, along with half of the economy section of the plane, were on their way to a two week tour of South America. All of the tour participants were of retirement age or older, wore gold watches and jewelery, and lived in some of the nicer residential areas of Istanbul. They collectively represent a sort of golden generation of Turks, who were born toward the beginning of the Turkish Republic. Ataturk's reforms have influenced the entirety of their personal and professional development. They are accordingly some of the staunchest defenders of secular and westernized Turkey, since it is they who largely realized Ataturk's vision and have been its greatest beneficiaries.

Mehmet began his career in the navy as a cadet at Turkey's naval academy and ultimately served as a electronics technician. He spoke with great pride about the technical training he received from the US Navy and also boasted that his daughter completed a masters in electrical engineering from a major American university. When Mehmet left the Turkish Navy, he started a manufacturing business with the technical expertise, which he had acquired during his career. His factory, which is located on the Asian side of Istanbul, has a vibrant business producing electronic components used in televisions made by Turkey's largest household electronic goods manufacturer, Vestel.

Mehmet's manufacturing business serves as a microcosm of Turkey's economic renaissance, which has particularly bloomed during the past few years of the AKP leadership. No longer dominated by state-owned businesses, agriculture and textiles, Turkey's economy emerged from a politically tumultuous period in the 1990s with an aggressive approach and strong support from foreign investors. According to the president of the
Turkish Confederation of Businessmen and Industrialists, Rızanur Meral, 60% of Turkey's exports are purchased by European Union members. Turkey's historically weak currency, lower wage levels, emerging domestic economy, long-time NATO membership and proximity to Europe have made it a logical location for manufacturing growth.

While the lure of these conditions continues to prevail for the most part, Mehmet's forecast for the future of his business would appear to have great relevance to the prospects of the Turkish economy in general. "In three years I will have to close my production line," Mehmet predicted. In order to compete with Chinese manufacturers vying for Vestel's supply contracts, Mehmet's business has been forced to cut the price of its electronic components. These cuts will eventually render his domestic production operations completely unprofitable - a phenomenon that is relevant to many of the world's emerging market economies including Turkey.

Mehmet's story exposes one of the many vulnerabilities of the Turkish economy, which this observer views as an increasingly visible theme for 2008. While Turkey's labor costs may be low compared to Western Europe or even most of Eastern Europe, it offers little advantage when compared to India or China. Moreover, raw material costs in India and China benefit from substantial state subsidization. Due to Turkey's considerable trade with Europe, local Turkish suppliers of raw materials have raised their prices to European levels and the Turkish market furthermore does not feature nearly the same level of raw material subsidization.

Throughout 2007 the great strength of the Turkish lira, buoyed by record levels of foreign investment covering Turkey's growing deficit as well as by substantial foreign exchange trading, kept pace with the rising price of oil. Unlike in the US economy, which has felt the effects of higher energy costs, the Turkish economy was relatively buffered. Despite this situation,
the following analysis from a Bloomberg article references a chronic fault in Turkey's manufacturing system.
“The essential problem for Turkey is the fact that manufacturers rely on imported goods to make products,” said Şengül Dağdeviren, economist for Oyak Bank in Istanbul. “Whenever exports increase, imports go up accordingly.” Exports rose 30 percent to $11.3 billion in November, a record for a single month, the statistics agency said Monday. Imports increased 29 percent to $16.6 billion in November from the year-earlier period, the agency said.
The Turkish government has responded to this situation by calling for Turkish manufacturers to pursue more value-added products. However, this observer wonders how moving up the value chain for manufactured products will alleviate Turkey's troublesome import-export cycle. Value-added products will make the country's exports worth more, but they will still require Turkey to import the necessary inputs - perhaps even at greater levels of cost.

The Turkish economy thrives on political stability and it appears unlikely that the magicians in the AKP will be able to ensure such conditions for 2008. The political calendar in 2008 will be marked by the inevitably heated battle over the series of constitutional reforms desired by the AKP. In addition, Prime Minister
Erdoğan has demonstrated considerable resolve to overhaul the country's social security system, which is a key sticking point for Turkey's relationship with the IMF and with the European Union to a certain extent. At the moment, roughly 8m Turks directly receive social security payments and "90 percent of the Turkish population is directly or indirectly a part of the social security system" according to this article in Today's Zaman.

The legacy of last year's drought, the potential for military activity related to the PKK and interruptions in energy cooperation with Iran and Russia could also contribute to the brewing storm, which will hamper Turkey's economy in 2008. With slower levels of growth predicted for the coming year, Turkey and its AKP-led government must be extremely sensitive to the social and ethnic tensions that will most likely rise as the general climate of economic prosperity dissipates. It is this potential for unrest in Turkish society, which ultimately represents the greatest threat to the near-term progress of the Turkish economy, in addition to the nation at large.