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.

"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.

Considering the Turkish Economy and the Conditions of its Success

The Turkish economy is currently moving at full throttle. Not since the privatization reforms of the venerable Turgut Özal has there been such a sustained stretch of economic progress. While the average Turk will point to the fact that unemployment, which probably unofficially hovers at 14-16%, remains a sizable dampener to overall well-being, a considerable cross-section of Turkish society would nonetheless agree that the country's economy is enjoying unprecedented prosperity.

Taxi drivers in Istanbul and even the heads of conglomerates will tend to point to the same rationale for this long period of positive growth: the political stability experienced under the AK Party. There is little dispute that Turkey's current period of economic success correlates nicely with the starting date of the AKP's leadership of the Turkish political system. In a country that is accustomed to military coups, hyperinflation and dramatic terrorist attacks, the AKP's tenure has been quite serene by Turkish standards. This point was not lost on the AKP during the July parliamentary election and Abdullah Gül's subsequent successful bid for president. Many Turks voted for the AKP simply due to economic issues and not as a result of the party's much ballyhooed portfolio of social views.

These calm conditions have given foreign investors cause to increasingly reward Turkey with much needed sources of investment. Foreign capital inflows have been quite often directed toward the very large number of government assets, which the AKP has aggressively sought to privatize. The growth of exports have also played a prominent role in the country's economic resurgence. According to the head of the Turkish Congress of Exporters (TIM), Turkey's exports exceeded $100bln during the past 12 months for the first time in the country's history. Exports of automobiles took the lead, followed by clothing and textiles and steel-iron in a distance third.

The numbers would indeed seem to indicate that AK Party is doing something correct. However, "the numbers" only tell a small sliver of the entire story as is often the case. In addition to the AKP's adept management and calming presence, one must also consider certain other factors that have equally contributed to the situation.

There has been a great prevalence of "petrodollars" in the Middle East looking for "shariah-compliant" homes for investment. Under the unprecedented political auspices of the religiously conservative AKP, Turkey emerged as a much more viable option for this capital. In this regard, the Turkish economy of the AKP era has been a direct beneficiary of the oil-crazed world and its oil market. Second, the availability of inexpensive products from China has also had a great influence on the Turkish economy. In addition to increasing the buying power of the Turkish consumer, cheap Chinese products have so far been a benefit to the non-textile sectors of the Turkish economy. This has particularly been the case for the outsourcing of component parts, which are used for goods manufactured in Turkey.

All of this should be reconsidered in the increasingly gloomy shadows cast by the foreign trade deficit, which Turkey currently maintains. In addition to considerable spending in the public sector, Turkey's great affinity for imports is strongly driven by its energy consumption needs. While this situation is more palatable during periods of reliable foreign investment, the continued strength of such inflows is certainly ephemeral.

In the opinion of this observer, it is time for the AKP to stop riding on its somewhat false laurels concerning economic management. The AKP must instead use its strong political mandate to take the types of tough measures, which are necessary to cushion the Turkish economy's inevitable descent into more turbulent economic waters. If the AKP chooses not to take such steps, it will eventually find itself in equally hostile circumstances.

Considering Turkey's Transport System

A recent article in Zaman about the state of Turkey's highway system encouraged this observer to consider the current and future state of transportation in the Republic of Turkey. Visitors to Turkey will no doubt remark the ease with which the individual traveler can move from one part of the country to another. Turkey's private bus, dolmuş and taxi network arguably represents one of the most formidable achievements of the Turkish experiment with capitalism. The not so uncommon image of a sheep strapped to the roof of a dolmuş minibus underscores the importance of this network to the development of the domestic economy over the past decades.

As is the case in all countries, the suitability of logistics network is one of the keys to economic growth. In its position as an emerging market economy, Turkey is faced with the typical challenge of upgrading its logistics infrastructure in order to meet the criteria of foreign investors. The aforementioned bus, dolmuş and taxi network is not particularly relevant to the logistic needs of modern industry.

The challenge of strengthening a country's logistics infrastructure has traditionally fallen on the back of the public sector. More recently, there has been a growing liberalization of state control over strategic assets. A deluge of worldwide private investment has ensued. Turkey's ruling AK Party has embraced this trend, having already sold off significant portions of Turkey's infrastructure portfolio. Most recently the port of Izmir was sold to Hong Kong-based Hutchison-Whampoa for $1.25 billion. Similarly, Germany's Fraport bought the operating rights to Antalya's airport for $3.2 billion. Although such sales inevitably arouse suspicion concerning whether the government received fair value, the fact remains that these infrastructure assets are better off in private hands in terms of the future investment that they will receive.

While seeking suitors for its existing assets, Turkey's government has turned its attention toward the development of the country's road system. In line with the seaports and airports, the government is trying to sell the management rights to the country's existing toll-roads and toll-bridges. This strategy of selling toll-road concessions is the key to Turkey's ability to afford the creation of new highways across the country. The construction of a highway linking Gebze-Orhangazi-Bursa-İzmir is already underway, and another such project linking Ankara with Izmir will most likely begin in 2008. When the AK Party took power in 2002, it aimed to build 15,000 kilometers of new roads. Roughly 4,000 kilometers have already been completed.

Like public works projects all over the world, the AK Party's program is not without its inequities. For example, the number of roads built in the region of Kayseri (770km), which is a traditional stronghold of the AKP, is greater than any other part of the country by more than 100 kilometers.

Beyond this type of age-old political dilemma, there exists the broader question of whether the AK Party's emphasis on roads is in fact prudent. Istanbul's traffic is already horrific and the construction of a system of wider roads elsewhere will only cause this phenomenon to spread to other locales. In light of the rising costs of petroleum of which Turkey has nearly none, this observer wonders if is truly wise to concentrate so much of the country's infrastructure investment on motorized transportation.

As it turns out, Turkey has a very long, albeit largely unfruitful, history of train transportation. British military activity in Egypt and Iraq during WWI was largely motivated by an urgent need to stop Germany's ambition to build a rail connection between Berlin and Baghdad via Anatolia. A subsequent effort by Ataturk to expand the country's rail network was cut short by the leader's death.

Therefore, the majority of Turkey's contemporary railroad network was built at the beginning of the 19th century by German engineers, who were paid by the kilometer. As a result, Turkey's rail routes are far from direct. A cross-country train voyage is not only dangerous, but it also takes an eternity. This state of affairs exists in stark contrast to the modern Mercedes coach buses and trucks, which can complete the same journey in half the time and twice the comfort, safety and reliability.

If Turkey is to improve the competitive position of its economy in the future, it ought to pay more attention to the realities of today's world. European governments are aggressively investing in linking together their rail infrastructures since they realize the economic benefits this will add to their increasingly integrated economies. Even America, which boasts the world's most impressive highway network, relies on its railways for a great deal of freight transportation. Initiatives like the Trans-Asian Railway Network are the future and are highly complimentary to Turkey's desires to function as a gateway between Europe and Asia.

Developments such as fast-train service connecting Istanbul to Ankara (and eventually Ankara with Konya) as well as the recent announcement of the reconstruction of the Baku-Tbilisi-Kars railroad in the near future are encouraging although insufficient. To meet Turkey's future economic ambitions, laying new and reliable track would not only benefit interior Anatolia's highly agrarian economy, but it will also encourage more dynamic industrial development.

The construction of more roads possesses the short term benefit of helping the country's growing automobile industry as well as the pockets of its bus company tycoons. However, this decision would appear to have unfortunate consequences for the Turkish economy's long term competitive position.