Meanwhile, the government is seeking to bolster its power after an unsuccessful coup attempt last July. How the country handles these myriad issues could set the stage for either an economic recovery or a further descent into crisis.
Syrian civil war stresses
Turkey shares a 500-mile border with Syria, and it is estimated that over three million refugees have found their way north since hostilities began six years ago. Absorbing such an influx would be a challenge anywhere, but it is particularly troublesome here. Turkey has a relatively young population with an average age of 29, and is experiencing a rising unemployment rate that hit almost 12% in February. Meanwhile, the government has issued over 400,000 temporary work permits for displaced Syrians, and many are seeking work in the black market. This has led to considerable resentment among residents toward the refugees, with rising complaints that they are “stealing” Turkish jobs.
Tourism has suffered, but may be experiencing a turnaround
Turkey has recently suffered terrorist acts from multiple groups, and these events along with the attempted coup, the Syrian civil war and a dispute with Russia that resulted in a now-lifted travel ban have had a significant impact on tourism. For 2016, revenue from tourism plunged 30% to the lowest result in nine years. However, April 2017 showed a rise in foreign visitors for the first time since August 2015.1 Tourism used to be a major growth area as well as a crucial source of foreign exchange, so the stakes are high.
Coup fails but does lasting damage
On July 15, 2016, a faction of the military launched a coup against President Recep Tayyip Erdoğan. It ultimately failed, but President Erdoğan has had the country under emergency rule ever since. Now, he plans to implement a raft of anti-democratic reforms with the aim of increasing his power. The reforms, narrowly approved in a referendum on April 16, will dismantle Turkey’s parliamentary system, abolish the office of prime minister and transfer all executive power to President Erdoğan. This will give him the ability to hand-pick all government ministers, senior civil servants and members of the judiciary.
In addition, the government has seized over 600 businesses (with total assets exceeding $10 billion) that have suspected links to Fethullah Gülen, the exiled cleric that is thought by many to have orchestrated the coup. This partial nationalization was obviously a red flag to potential investors in Turkey.
Improvement seen in some areas
Despite the current turmoil, Turkey has made progress in certain areas since President Erdoğan came to power in 2002. In the preceding decade (1994–2003), money growth (M3) was excessive, averaging nearly 85% year-on-year, and by early 2002, Turkey’s Consumer Price Index had soared to 73%. The implementation of more prudent monetary policies gradually brought the growth of M3 under control, reducing the average increase to 17.6% year-on-year from 2003 to 2014. With these actions came a corresponding drop in inflation to less than 10% annually during the same period. Although inflation has ticked up recently, it is not expected to accelerate past 13%.
Turkey’s balance of trade has recently been improving. While imports rose 7.7% in March year-on-year, exports jumped 9.2%. This trend has helped narrow the current account deficit in recent quarters. The improvement appears to be more the result of reduced oil prices than increased export competitiveness, although the depreciation in the Turkish lira (TRY) has concurrently made domestically produced goods more affordable to foreign buyers.
While providing a short-term boost to exports, the level of lira depreciation is still unhealthy. Consider that in November 2010, the TRY/USD exchange rate was 1.4 — today it is 3.53, which means the lira has halved in value in dollar terms over seven years. It is also down 18% against the euro since the beginning of 2016. A portion of this depreciation can be attributed to the overexpansion of private sector balance sheets, particularly between 2009 and 2014. Much of this lending was funded by foreign lenders, but since then both business and consumer lending growth has slowed.
Between 2002 and 2007, Turkey’s real gross domestic product (GDP) grew at a vigorous rate of 6.8% annually. For the 2009 through 2015 period, growth slowed to a still-strong 5.6% annual average, but a combination of political instability, regional turmoil and the failure to implement structural reforms led to a more precipitous drop, with GDP actually contracting in the third quarter of 2016. This seems to have been the nadir, as GDP growth returned to positive figures in the fourth quarter of 2016 and the first quarter of 2017. The consensus forecast for 2017 growth is 3.2%.
The official line on the causes of the economic contraction included weaker global trade, shrinking inflows into emerging economies, the failed coup and low rainfall. To address this problem, the government devised an ambitious program of structural reform to increase potential growth and reduce external imbalances by increasing domestic savings, raising productivity and broadening labor market participation. Unfortunately, government spending has been the brightest spot. The performance of the Turkish private sector has steadily weakened due to the international and domestic political shocks in recent years. This shift in the composition of growth forms part of a broader trend toward a greater role for the state in the economy.
Extending the reach of the state
Government intervention in the banking sector has also increased via state-owned banks and state-directed lending. Similarly, the government has created a sovereign wealth fund to oversee the investment of national assets (including the seized companies) and a credit guarantee fund of 250 billion lira.
There seems to be a major power struggle between two camps in the Turkish government and Central Bank of Turkey (CBT). First there is the “sound money” group that wants to control inflation, slow money and credit growth, and end the depreciation of the lira via tighter monetary policy. On the opposing side, there are the populists who want to loosen monetary policy to stimulate economic growth and assist specific sectors such as construction. The increasingly populist President Erdoğan sympathizes with the latter group, but has so far allowed the CBT to pursue monetary policy relatively independently. Given that he has reluctantly conceded to macro-tightening to prevent a collapse in the lira, he could very well change his mind and put pressure on the CBT to loosen policy if it is politically expedient to do so.
What’s next for Turkey
After strong results in the early 2000s, growth has slowed and Turkey is facing large macroeconomic imbalances along with other challenges.
- It has a significant current account deficit (which has been funded by foreign borrowing) and large foreign exchange liabilities. With the lira continuing to depreciate, the cost of servicing these debts is rising. Under the current regime, this pattern seems likely to persist.
- Based on maturity schedules, Turkey will need to refinance about $200 billion in debt during 2017.
- The Turkish currency situation is unlikely to improve until the CBT is granted more independence, something that looks even more unlikely following the constitutional referendum on April 16.
- Turkey needs greater business investment from either domestic or foreign sources to sustain growth and job creation. Unfortunately, investors have become more cautious on emerging markets of late.
- Turkey’s hope of joining the European Union was dashed last November (in response to the government crackdown following the coup attempt) when the negotiations that began in 2005 were frozen.
- Unemployment is still high, and the civil war in Syria is causing domestic pressures.
- It remains to be seen whether the recent uptick in tourism will be sustainable.
While some of these conditions are clearly beyond Turkey’s control, it is safe to say that how the government responds to these challenges will likely determine if the country will be able to resume the type of growth path it experienced in the past.
The iShares MSCI Turkey Investable Market Index Fund (NYSE:TUR) was unchanged in premarket trading Wednesday. Year-to-date, TUR has gained 25.32%, versus a 8.71% rise in the benchmark S&P 500 index during the same period.
1 Source: Bloomberg News, “Tourists are finally coming back to Turkey,” May 30, 2017
The consumer price index (CPI) measures change in consumer prices as determined by the US Bureau of Labor Statistics.
M3 is the broadest measure of an economy’s money supply.
Where John Greenwood has expressed opinions, they are based on current market conditions as of June 14, 2017, and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. Unless otherwise specified, data was supplied by Mr. Greenwood. Past performance is not a guarantee of future returns. An investment cannot be made in an index.
This article is brought to you courtesy of Invesco.