Turkey’s Growth Is Strong— But Challenges Still Abound

An Institutional Investor Sponsored Report on Turkey

Turkey’s economy grew at a faster pace than expected in the first quarter of 2014, recording a 4.3 percent expansion. In late June, the World Bank revised its 2014 growth estimate from 2.4 percent to 3.5 percent, while the OECD forecast 3.3 percent. Turkey’s chronic weakness, its large current account deficit, also saw an improvement in the first half of the year.

By Nicole Pope

Thanks to exports rising 5.7 percent to $92.7 billion in the January to July period, and regulatory measures introduced to curb loan growth, Turkey has improved its current account balance. “We expect a meaningful correction in the current account to GDP ratio from 7.9 percent in 2013 to 6.1 percent in 2014, and to record a further improvement to 5.6 percent in 2015,” says Serkan Özcan, Assistant General Manager in charge of Economic Research and Strategic Planning at Odeabank. “However, risks to our current account expectations are tilted to the upside due to the recent escalation in geopolitical concerns and its reflection on oil prices.” Indeed, the challenge facing the country now is to maintain these positive trends while facing uncertain global and domestic economic and political factors.

Erdoğan’s expanding power

Turkey attracted $20 billion in capital inflows last year. But with global liquidity tightening, investors are expected to be more selective and sensitive to political risks. On August 10, Recep Tayyip Erdoğan, prime minister since 2003, became Turkey’s first popularly elected head of state, winning just under 52 percent of the vote. He was sworn in as president in late August. His party has named Ahmet Davutoğlu, who has been foreign minister the past five years, as the new prime minister. Erdoğan’s presence provides continuity, but Turkey is entering unchartered political territory.

An increasingly authoritarian figure, the new head of state has already signalled that he won’t confine himself to the mostly ceremonial duties assumed by previous presidents, and intends to continue playing an active role. A new prime minister, chosen among his close party associates, will head the new cabinet until parliamentary elections due latest by June 2015.

Investors are now focused on who will be in charge of the economy. Deputy Prime Minister Ali Babacan, at the helm for most of the past decade, has won the respect of investors for his commitment to fiscal discipline and balanced growth, but he faces a party-imposed three-term limit at the next elections, and may even be left out of the next cabinet. In recent months, dissonant voices have emerged from the government on economic policy. Mr. Erdoğan has also been pressuring the Central Bank to cut interest rates more aggressively.

Since May, the Central Bank, which had intervened with a bold rate hike in January to support the struggling Turkish lira, has lowered its benchmark rate by 175 bps to 8.25 percent, below inflation level. Its inflation outlook has proved overly optimistic. In July, CPI rose more than anticipated to 9.3 percent year-on-year, partly due to the impact of a drought and rising food prices. Turkey will, once again, miss its year-end inflation target, currently set at 7.6 percent.

In a note published on August 11, Fitch Ratings, which rates Turkey BBB- with a stable outlook, pointed out that “macroeconomic outcomes so far in 2014 have been broadly positive for Turkey’s credit profile”, but it did mention the Central Bank’s “already tenuous credibility.” Moody’s also stated on August 15 that “until the political landscape reaches some stability, the country’s structural reform agenda is likely to suffer, leaving Turkey exposed to potential shifts in international market sentiment.” Moody’s confirmed Turkey’s Baa3 rating in April, but it revised its outlook from stable to negative.

“The deterioration in investors’ perception of Turkey can be easily observed from the value of the TL against other major emerging economies,” explains Serkan Özcan. “As of August 8, the Turkish lira is undervalued by 4 percent against emerging countries currencies, compared to December 17, 2013.”

In the days following the presidential poll on Aug. 10, political concerns triggered a weakening of the Turkish lira to 2.16 against the dollar by mid-August. The main Borsa Istanbul index, which has gained over 16 percent this year, retreated from a high of 84,218 on July 25 to 77,342 on August 18, 2014. Yield on the 10 year government bond rose from 8.88 percent in July to 9.28 percent in August.

Still an attractive market

For all the current uncertainty, Turkey remains an attractive market. “The central budget is still fine and the deficit is below 3 percent of GDP, although it is widening compared to last year,” says Mehmet Besimoğlu, chief economist at Oyak Securities. “But one-offs from privatizations are making the picture rosier, and in the future there will be no one-offs.”

Turkey’s public debt ratio is also low at 36 percent and funding the balance of payments deficit is not an issue. The country’s young population and geographical location also offer potential for further growth, albeit at a slower rate. Turkey’s economy is also underpinned by a banking sector that remains solid, if less profitable.

The operating environment has been tougher for Turkish lenders, which have seen their profits decline in the first half of the year due to slower loan growth and higher interest rates. A slight recovery was registered in Q2, yet profits were still lower than during the same period last year; for Akbank, the decline was 2.3 percent, while Garanti’s was 8.6 percent. Public lender Halkbank, which saw profits reduced by 12 percent, recently announced its intention to bid for a 76.76 percent stake in Serbia’s Cacanska bank.

“Total loans increased by only 7.1 percent in the first half compared to year-end 2013, but we expect stronger loan growth in the second half of the year on the back of the declining in loan rates,” says Serkan Özcan of Odeabank.

Islamic participation lender Bank Asya, linked to the faith-based Gülen movement, currently engaged in a power struggle with the ruling party, saw first half profits drop 81 percent. Trading of its shares on Borsa Istanbul (BIST) was suspended indefinitely in August, after talks on a possible acquisition by Qatar Islamic Bank ended.

Banks are well-capitalized

Overall, Turkey’s banking sector remains well-capitalized and the NPL ratio across the sector stands at a relatively low 2.76 percent. “Banks are having no problem with their external borrowing,” says Mehmet Besimoğlu. “In fact, they’ve managed to extend maturities and their capital adequacy ratio is still much better than their peers.” Foreign lenders continue to see potential in Turkey’s large market of 77 million. In April, Industrial & Commercial Bank of China Ltd. announced it would buy 75 percent of Turkey’s Tekstilbank from GSD Holding for $316 million.

To take its economy to the next level, Turkey needs reforms in fields such as education and taxes to boost its competitiveness and transition to more high-tech, value-added production. Low female workforce participation, currently around 30 percent, is also a handicap. “We need stability and team work. I’d be very happy if I saw a coordinated and realistic macro plan, with targets and tools, involving the Central Bank and all the ministries.” explains Burcu Ünüvar, economic consultant and economics lecturer at Yaşar University. “We have to do our homework.”

Most analysts agree, however, that a long-term strategy involving significant improvements in the institutional framework is unlikely to emerge until the election cycle is completed and Turkey has a new parliament.