Turkey’s economy can sometimes seem a curious tangle of contradictions. A regional export powerhouse, shipping goods to Russia, North Africa and the Middle East, it is also curiously dependent on imports, notably foreign energy and capital. It runs a large current account deficit while maintaining a quite low overall stock of public debt.
Most curiously, this entrepreneurially vibrant economy, underpinned by an overwhelmingly young population, remains stuck in second gear, despite a decade of growth and largely positive reform.
This is not a struggling economy by any means. To see one of those, stand in Istanbul and look in any direction. To the southeast stand the scarred nations of Syria and Iraq; to the southwest, the troubled transition economies of northern Africa. Further afield, yet more battered buyers of Turkish goods: recession and sanctions-hit Russia; and the lumbering, bruised eurozone.
What the leaders of many of those stumbling states would give to be in Turkey’s shoes. Gross domestic product grew by 2.3% year on year in the first quarter of 2015, beating consensus forecasts of 1.8%.
Much of the good news stemmed from private consumption, which remained “surprisingly strong”, Barclays’ emerging markets economist Durukal Gun said in a June 10 research note, expanding by 3% on an annualised basis in the first three months.
Kubilay Ozturk, an economist at Deutsche Bank, said in a note published the same day that while strong consumer data was “on the cards” given higher loan growth in the first quarter, “the extent of improvement was beyond our expectations”.
In a normal world, this outperformance should not come as a surprise. Turkey’s lack of carbon-based energy has long been seen as a distinct disadvantage, given its high rate of industrial output, and its large and growing populace. When prices are high, imports of Russian gas and Iranian oil weigh heavy on the country’s finances. In a December 2014 report, the World Bank noted that the nation’s external energy shortfall accounts for 58% of Turkey’s trade deficit.
This problem though swings both ways. Sharply lower oil prices, which at the time of writing had stabilised at around $60-$65 a barrel, offered “the single biggest reason to be optimistic about Turkey’s economy”, says Marcus Svedberg, chief economist at emerging market investment manager East Capital. “Turkey in theory is one of the biggest beneficiaries of lower prices anywhere in the world.”
In its December note, the World Bank said that a “sharp decline in energy import prices — if sustained — will support stronger growth, external adjustment, and disinflation in 2015”.
Oil price lost in translation
Yet heading into the second half of the year, that theory has yet to be rendered into reality. GDP may have surprised on the upside in the first quarter, but to many, it remains surprisingly sluggish. Economic growth averaged 9% in 2010 and 2011, but it is tipped by the World Bank to come in at 3% in 2015, and to average 3.4% over a four year span stretching to end-2017. Moreover, falling global energy prices have so far failed to translate into lower consumer prices. The annual domestic rate of inflation actually accelerated in May, to 8.09%, from 7.91% the previous month, according to data from TurkStat. That marked the highest level in 2015, underpinned by rising transportation and housing costs.
Many now fret that Turkey will continue to struggle to kick its economy into a higher gear, creating negative shorter and longer term repercussions. In the near term, this means a stodgy economy unable to cut debts, attract new inward capital and create enough new jobs.
East Capital’s Svedberg says that while the economy may pick up in the second half of 2015, it is “unlikely to be a great year in terms of growth”. Turker Hamzaoglu, senior economist, Turkey and frontier markets, at Bank of America Merrill Lynch, says he remains “cautious on Turkey’s medium term outlook, as we argue that the current growth model is almost unsustainable. It needs to change, and to be replaced with a more competitive framework. It has been dragging down GDP growth and keeping inflation high.”
Hamzaoglu points to three main weaknesses in Turkey’s macro story. First, a secular slowdown in GDP growth, with productivity gains completely evaporating, and political uncertainty rising. Second, sticky and high inflation and that is also connected to a structural slowdown in growth. And finally, a sharp increase in leverage. Private sector borrowing rose to 70.2% of GDP in 2014, from 47.1% in 2010, according to data from the World Bank. Credit card debt grew by an annual average rate of 77% over the same period.
Many also fret that Turkish corporates may struggle to repay their debts, 90% of which are denominated in foreign currencies, notably the euro and the US dollar.
Avoiding the middle income trap
The longer term challenge is how to inject enough fresh growth into an economy that shows signs of becoming stalled. Few nations have succeeded, over the past several decades, in avoiding the middle income trap (most nations that have done so lie in Asia, notably South Korea, Taiwan, and Singapore). Turkey’s problem here is stark; the outcome maddeningly unclear.
A February 2015 paper by the Brookings Institution highlighted the challenge facing the country. On the one hand, the US think tank said, a country that was an effective basket case at the turn of the century has made enormous and at times extraordinary strides. Per-capita income increased by 260% between 2001 and 2013, according to the World Bank, and the government has pledged to more than double average annual income, to $25,000 by 2023.
Yet in recent years, “confidence has given way to doubt as growth rates have moderated,” the institution warned, raising concerns that Turkey will “remain trapped in middle income status”.
Historically, the only sure way to achieve developed nation status is through sustained and high long term levels of growth (by, say, replicating the sustained boom achieved between 1962-1977, when Turkey’s economy grew by an average annual rate of 6.2%) while avoiding the sort of spectacular booms and busts that have long hampered its potential. The country still remains on track to avoid the trap, the US consultancy insists. “We estimate that Turkey’s [average annual] growth potential over the next two decades is around 4.2%, enough to ensure high income status,” it said.
A key ambition must be to create the kind of solid institutions taken for granted in first world countries. In particular, Turkey will need to transition from clientelism to a more meritocratic system, where individuals are rewarded for what rather than who they know. “Turkey started on this transition with major institutional reforms implemented over a decade ago,” Brookings said in its February 2015 paper. “But for the last five years, the process has slowed and the reforms remain contested and incomplete.”
Political upheaval
These are challenges that will likely fall to a new generation of leaders, following landmark general elections held on June 7. That poll, effectively a referendum on president Recep Tayyip Erdogan’s attempts to rewrite the constitution and grant himself wider-reaching powers, resulted in a pyrrhic victory for the Justice and Development Party (AKP). Erdogan’s former party garnered the largest single block of votes, but proved unable to secure an outright majority, resulting in the first hung parliament since 1999.
Turkey now faces a period of political uncertainty that may last months. If a new government is not in place by July 22, ruled either from a minority position by the AKP, or through a majority or grand coalition, a snap election will need to take place. Yet even that may not be enough to ensure long or even medium term political stability. A few months ago, notes East Capital’s Svedberg, “the assumption was that the AKP would win a majority, without necessarily securing a mandate to rewrite the constitution. Now the question has switched to what a successful coalition would look like. There is lots of uncertainty on the table.”
The broader concern is that political chaos is only likely to fuel economic uncertainty. Before the June poll, AKP leaders had been hard at work, assuring international investors that once the election was out the way, there would be “blue skies, and that structural reforms and sensible policies would again be introduced,” says BAML’s Hamzaoglu. “In a way, the elections have blown that notion to bits. We see a coalition as being more likely than early elections, but whether any coalition could last four years remains to be seen. It will be very bumpy for the next few months at least.”
And that period of turbulence — how long it lasts, and how much damage it does — will matter, for two reasons. First, because a clouded political outlook is likely to subdue economic output, and to deter would-be investors. Until the country’s new political framework is set in place, the country’s capacity to attract foreign inflows against an already unsupportive global background “could become more curtailed”, Deutsche Bank warned in its June 10 report. The German lender noted that given the “subdued likelihood for a return to a more stable government set-up any time soon”, it was revising downward its full-year 2015 growth forecast to 3%, from 3.5% earlier.
The second reason is the likely exit from public service of some wise and much-needed old heads. When former economy minister Ali Babacan and current finance minister Mehmet Simsek speak, foreign investors listen. “These guys know what they are doing,” notes East Capital’s Svedberg. “They were always talking to investors, and there is a concern that if they leave, and are replaced by a less economically literate or reformist group of politicians, that would be a concern. Turkey is very dependent on foreign capital — that’s not going to change — and so they need to continue to convince international investors that the country, and the economy, are heading in the right direction.”