Turkey’s financial managers and citizens are rubbing their eyes in disbelief. A country that was once the economically sick man of Europe is walking again. More than that, in some important respects, it is running ahead faster than many thought possible.
A combination of favourable economic circumstances is imbuing market players with a welcome sense of optimism and confidence. Economic stability now looks not merely predictable but also sustainable. Inflation is steady and declining, growth is rapid and interest rates are falling.
The country’s prospects have been improved by three factors. First, the IMF’s involvement in Turkey’s economic management; second, a rapprochement with the EU, leading to optimism that its request for accession will be granted in the next five years; and third, the election of a single party, the Justice and Development Party (AKP), as its government in 2002.
The election has brought to an end a long period of vacillating coalition governments. Moreover, this government has brought a no-nonsense monetarism to economic management that eschews political lending. This was the downfall of previous administrations and, ultimately, of Turkey’s economy during a series of financial crises at the beginning of the decade.
Ratings upgrade
The optimism in Turkey has percolated to the ratings agencies, which have recently upgraded the country as a sovereign borrower and also upgraded local bank borrowings on the international capital markets. Standard and Poor’s (S&P) raised the government’s foreign currency rating from B+ to BB-, bringing it one notch higher than ratings by Moody’s and Fitch.
S&P director Konrad Reuss said: “The sovereign upgrade reflects the progress Turkey is making towards durable macroeconomic stability. Turkey’s announcement, which clearly spelled out a continued commitment to the economic programme beyond the current IMF agreement, helped to dispel a lot of uncertainty around the credit.”
Structural reform
IMF support for the Turkish economy has resulted in considerable domestic restructuring. Pressure has grown on the government to speed up privatisation, which had been lagging. Moreover, poor state management of areas like the social security and tax collection systems is also being tackled. Today’s government is making the social security payment process more efficient and tightening up on revenue collection, an area in which the country has fallen down badly. It was recently argued that at least 60% of the economy was not subject to taxation.
Structural reform has also been introduced into some of the country’s key financial agencies. For example, the Central Bank of Turkey has been granted a degree of independence from government, which has made it more effective.
According to Mahmut Kaya, an executive vice-president at Garanti Securities: “For the first time in years, there is hope of stability where you no longer question whether the government is functioning. The Central Bank of Turkey has never been so independent. It used to be like just another state bank for the politicians. It was literally run by the politicians. That is no longer the case.”
The restructuring was part of a three-year package agreed with the IMF in 2002, which allowed the country to borrow $19bn to enable it to survive one of its periods of economic crises. Turkey was due to begin talks last month on another IMF package to take effect in February 2005, and sources in Ankara were confident that the government had made sufficient progress in implementing the IMF’s guidelines on structural reform to obtain a new deal.
Remarkable change
By almost every economic indicator, Turkey’s turnaround can only be described as remarkable. For example, just five years ago, the country was struggling to keep its inflation out of three figures and the economy was described as a basket case. Today, inflation is riding at around 12%, and there is a good prospect that the government will meet its 2005 year-end target of 8%. The vagaries of the oil price are unlikely to hurt the economy, say observers, as there is some slack in the performance of its prices.
Improvements in productivity are also underpinning the inflation rate. According to Serhan Cevik, a Turkey analyst at Morgan Stanley: “Turkey’s labour productivity in the manufacturing sector accelerated from an average of 3.8% in the 1990s to an annual rate of 10.2% in the last three years, resulting in a cumulative increase of 30.4% in output per worker. Given the sharp rise in capital-to-labour ratio, the inflation outlook remains quite favourable.”
Declining inflation has helped the country to reduce interest rates it pays on its local borrowing. These range at about 25%, indicating a real interest rate (net of inflation) of 13%. Belma Ozturkkal, general manager of Koc Securities, expects the rates to fall over the next year, as inflation drops. “The central bank and the treasury are doing a very good job of bringing real interest rates in the local markets down from 30% levels to levels closer to 14% or 15%, which is very good progress.”
Turkey’s risk premium will continue to fall as economic management remains tight. “If the government continues with strict fiscal policies then the risk premium on the Turkish debt will decline and that will even further accelerate the drop in interest rates,” says Ahmet Erelcin, HSBC’s general manager in Istanbul. “So both inflation and government policies will play a critical role in ensuring Turkey’s future economic well-being.”
Debt worries
However Turkay Oktay, general manager of AK Securities, paints a less rosy picture of Turkish debt management, saying: “The maturity of local borrowings is very tight. The government has to borrow every 13 months to keep the balloon flying. If we didn’t have the IMF package, we would have to borrow more externally. The IMF makes the government’s life easier and it makes the real interest rates lower.”
The government’s tight rein on inflation has been reinforced by efforts to channel government funding away from the public sector and towards the stimulation of private companies. Turkey’s prime minister, Recep Tayyip Erdogan, said recently: “While the public sector is downsizing its expenditures and increasing revenues to maintain a primary surplus target of 6.5% of gross national product, private economic activity is also recovering quite quickly.” These efforts have paid off, as growth has been maintained at between 5% and 6%.
The fly in the Turkish ointment is the country’s current account deficit, which measures commercial external relations, in particular the flow of services, goods and investment income. This was expected to reach $7.6bn at the end of 2004 but the government raised its estimate to $10.8bn in August.
This revision provoked a warning from the IMF, which said: “Directors [of the IMF] saw the need to continue to monitor the rising current account deficit carefully.” The government responded by claiming that the rising tide of imports was composed of raw materials required to support domestic production and exports, rather than consumer goods. Observers who have witnessed the Turkish consumer’s insatiable desire for imports of electronic goods and cars, greet this comment with some scepticism.
Weak spot
Although Turkey has a primary surplus – the result of a tighter rein on government expenditure, privatisation receipts and growing tax revenues – the size of the interest repayments on its debt make it vulnerable to economic shocks, says the IMF. Turkey’s government domestic debt at the end of 2003 reached $97bn.
According to the IMF: “The size of the public debt, its short maturity and large foreign currency component make Turkey vulnerable to exchange rate and interest rate shocks… The quality of fiscal adjustment needs to be improved and the pace of structural reform intensified if the achievements to date were to be sustained and be carried forward in the form of medium-term growth.”
However, the IMF also speaks approvingly of a government composed of a single party with three years to run before it faces an election.
EU targets
IMF strictures aside, Turkey’s debt stock has been reduced from 92% of gross domestic product at the end of 2001 to 83.4% in 2003. Morgan Stanley expects it to reach 74% in 2004 and 56.5% in 2007. On this projection, Turkey comfortably meets the 60% Maastricht criterion.
The minister of state for the treasury, Ali Barbacan, said recently: “Politically, we are taking EU criteria as an anchor for the reform process. This makes the reforms in Turkey irreversible.”
However, Mr Cevik warns the government that “the currency composition and maturity profile of the debt stock make public finances vulnerable to shifts in investors’ risk appetites. This is why the authorities must keep consolidating fiscal gains and improve the quality of correction by addressing structural problems like the widening in the pension deficit.”
Turkey’s banking sector is reaping the rewards of the government’s commitment to the private sector. The crisis of 2001 forced the government to close or merge many state-owned banks, bringing their share of the country’s total assets down from 66% to between 45% and 50%. “Private banks have been able to increase their market shares and the days of unfair competition with state banks are pretty much over. Turkey now has a much stronger and more robust banking system,” says Mr Kaya.
