Last year’s plunge in oil prices breathed new life into Turkey’s economy and attracted a surge of interest from international investors, but the effect is fading fast. The energy-hungry country has perennially run a large current-account deficit and has one of the world’s highest net external debts; lower oil prices promised relief on both fronts. But “that story is long gone now because the oil price is not collapsing anymore,” says Benoît Anne, head of emerging-markets strategy at Société Générale. Instead, investors are preoccupied by Turkey’s political headwinds.
“The political environment in Turkey has been a major consideration simply because during these times of general nervousness in markets, investors are going to pay attention to factors such as credibility of policymaking, political risks, political uncertainty and the overall investment climate,” says London-based Anne. Turkey doesn’t score well on these criteria, agrees Sebnem Kalemli-Ozcan, economics professor at the University of Maryland and a Turkish native. There’s been a noted dip in foreign direct investment because of concerns about corruption, judicial independence and the general investment environment, she adds.
Most of those concerns stem from President Recep Tayyip Erdogan. He led the Justice and Development Party, known by its Turkish acronym, AKP, to power in 2002 by promising sound fiscal policies, a favorable approach to business and closer ties with the European Union aimed at Turkey’s eventual membership. That stance fostered an unprecedented economic and investment boom. But Erdogan served 12 years as prime minister and then became the nation’s first popularly elected president last August. As is often the case when politicians stay in power for too long, Turkey’s reform momentum and economic dynamism are waning, says Paul Psaila, head of EMEA investments at Morgan Stanley Investment Management.
There is one major reform looming over the country. The president hopes to transform Turkey’s parliamentary system into a presidential one, and he’s counting on a big AKP victory in June’s general election to make the change. It takes a three-fifths majority in parliament, or 330 votes, to amend the constitution; the AKP currently holds 313 seats. “That could be a futile abuse of power and could be frowned upon by investors,” Société Générale’s Anne says of the proposed change. Morgan Stanley’s Psaila contends that the proposal breeds political and economic uncertainty. “President Erdogan has made comments about the economy that show a lack of understanding and that are potentially market-unfriendly,” he adds, referring to Erdogan’s claim that high interest rates cause high inflation. Additionally, one of the most trusted stewards of economic policy, Deputy Prime Minister Ali Babaçan, is not allowed to seek a fourth term in parliament and will have to step down. His departure could deal a big blow to the government’s economic credibility, says Société Générale’s Anne.
A Société Générale survey found that Turkey has the least credible central bank among the emerging markets, along with Brazil and Nigeria. The Central Bank of the Republic of Turkey hiked rates sharply in January 2014 to curb a run on the lira and has trimmed rates modestly in recent months. Erdogan has pressed the bank to cut rates more aggressively to stimulate growth. Although inflation dropped to 7.6 percent in March from 8.6 percent in January, it remains well above the official target of 5 percent. Central bank governor Erdem Basçi has largely resisted the pressure, but analysts worry about threats to the bank’s independence. Rate cuts can occur only when volatility is low, which is not the case at the moment, says Société Générale’s Anne.
On the positive side for investors, Turkey offers high yields. The ten-year government bond yielded 8.04 percent in mid-April, compared with 1.9 percent for a ten-year U.S. Treasury bond. “It’s a risky asset because you’re exposed to the Turkish lira,” counters Anne, who notes that it has been vulnerable to rises in U.S. rates in the past. The lira has fallen about 20 percent against the dollar over the past year, as of April 10. Investors fear that a rate hike by the U.S. Federal Reserve could draw money out of Turkey. New York–based Psaila believes there will be some pullback in the availability of credit over the next 12 months and that Turkey’s economy will have to slow. The market is expecting 3.4 percent growth for 2015.
“There are competent people in charge of the economy who can steer the economy,” concludes the University of Maryland’s Kalemli-Ozcan. Turkey has enough pluses — a lot of investment in infrastructure, a young population, a dynamic economy — that investors can earn high returns. Ultimately, she says, the problem is one of political governance.
