Turkey’s economic resilience a worry

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Istanbul // On Wednesday morning, the Turkish army launched an incursion into Syrian territory led by ground forces and warplanes, triggering a new wave of political-risk driven losses in markets and the Turkish lira currency.

In what is it feared will further stir security problems along Turkey’s troubled borders, this was not the breaking news global investors wanted to hear about the Levant region’s leading emerging market. The incursion came as fears are growing for Turkey’s economic performance and its sovereign credit rating amid an possible rate rise by the US Federal Reserve. Shortly after the opening of Wednesday’s morning session, shares traded on Borsa Istanbul fell 2 per cent, bond yields rose while US dollar rose to 2.95 lira versus 2.94 at Tuesday’s closing.

Market observers have long been warning that the ongoing domestic political tension and clashes in the surrounding region will hurt Turkey’s already ailing economy more than anything. Months-long security concerns have already taken a toll on the economy, exacerbated by declining household consumption along with falling trade and tourism figures.

In the first half of this year, Turkish exports fell 2.4 per cent and imports by 6.7 per cent over the same period of 2015, the trade ministry said. Turkey’s tourism revenues nosedived to $4.98 billion in the second quarter, a 35.6 per cent fall year-on-year, the Turkish statistics institute said last month. Several ISIL suicide bomb attacks in major towns, a growing Syrian refugee issue, domestic political chaos and problems with such major trade partners as Russia are the polarising effects so far this year.

Acknowledging such downside trend, the deputy prime minister Mehmet Simsek said last week that Turkey will not be able to realise the targeted 4.5 per cent growth this year. The OECD has made the most optimistic growth estimate for Turkey, at 3.9 per cent, so far this year while the IMF puts this figure at 3.8 per cent. Next year’s government target is 5 per cent growth.

Against expectations, the G20 member shows a relatively strong economic resilience so far this year. Turkish GDP grew by 4.8 per cent in the first quarter this year, beating median market estimates. Such strong growth, however, is threatened by some key structural weaknesses in the Turkish economy, global monitors warn.

According to the World Bank, a slowdown in Turkish economy has been under way since as early as 2011. That came as private investment and productivity stagnated, a World Bank report released in July said. “The seasonally and working-day adjusted GDP growth slowed to an annualised rate of 3.3 per cent quarter on quarter in Q1, as compared with 4 per cent in 2015 as a whole,” the report added.

Analysts say, however, Turkey has proved to be more robust than anticipated. “I guess understandable that domestic demand will slow in response to security concerns following the failed coup and problems still in the tourism sector. But actually growth has been remarkably resilient under the circumstances,” Tim Ash, the head of the central and eastern Europe, Middle East and Africa desk strategy at Nomura tells The National.

One major concern over the Turkish economy is the central bank’s independence, or lack of it. The bank has long been criticised for bowing to political pressure to cut rates, and underestimating a growing inflation risk.

On Tuesday, the bank cut its overnight lending rate by 25 basis points. It kept its main policy rate unchanged at 07.5 per cent for the eighteenth month in a row. Market experts reacted saying that the bank assumes inflation will fall, although most expect it to rise to 10 per cent through the end of the year. Turkish inflation surged to 8.7 per cent in July from 7.6 per cent in June, well above the bank’s 5 per cent target.

“I think the market would prefer the bank to wait with rate cuts and adopt a more orthodox policy still. I think a more orthodox stance, given high inflation still, would be the best means to ensure that Turkey keeps its investment grade rating,” Mr Ash says.

The cut comes amid renewed pressure by the president Recep Erdogan to boost growth with lower lending costs. In its decision, the rate-setting committee led by the governor Murat Cetinkaya said the recent spike in food prices could revert soon and core inflation would improve gradually.

But the bank’s outlook is out of step with market expectations that inflation will remain above 7 per cent over the next two years, said William Jackson, a senior emerging markets economist at Capital Economics in London, according to Bloomberg.

“The council’s relentlessly dovish stance suggests that further rate cuts are on the cards – we have now pencilled in another 50 basis points of cuts this year,” Mr Jackson said. “We had actually expected the monetary policy committee to leave all its key interest rates unchanged as a result of the deteriorating inflation outlook.”

The decision suggests policymakers were influenced by global conditions and the performance of the currency after the failed coup, Mr Jackson said.

The credit rating agency Fitch lowered its Turkey outlook from “stable” to “negative” last week while rival Moody’s hinted at a possible downgrade to junk status.

Both agencies keep Turkey at investment grade, required to attract foreign cash inflow. Losing this status would pose a major challenge for the fragile Turkish economy, and spur bond sell-offs and debt pressure on banks and companies alike.

According to the former Turkey central banker and economist Ugur Gürses, the majority of investors in Turkey have adopted wait-and-see mode and markets have until the end of September to see exactly how the economy will perform. “What we are examining currently is a decline in corporate demand, imports and household spending. This is basically [due] to lingering political uncertainty,” he tells The National.

Still, he also believes the Turkish economy is resilient despite weaknesses and he adds that there is also strong growth potential should political tension ease.

On Wednesday, Turkish credit default swaps (CDS) spread back to 244.5 bps after jumping to 300 following the coup attempt on July 15.

Turkey has fought hard to power up its GDP but new fund may prove a burden

Despite its current woes, Turkey has expanded its nominal GDP to US$718 billion in 2015 from $483bn in 2005 thanks to rising foreign direct investments (FDI).

That growth was welcome as it triggered credit growth and domestic consumption, two of the main drivers of GDP expansion.

The increases were backed up by rising exports and private investment at home.

Following the failed putsch attempt on June 15, which the government said may have cost Turkey as much as 100 billion lira (Dh125.01bn), and accompanying growth concerns, Turkey is now embarking on some unorthodox measures to breathe life into economy.

A recently introduced sovereign wealth fund is one such – but experts warn this step threatens to curb Turkish market resilience while denting investor sentiment.

In a report on Monday, Roubini Global Economics said the new fund will result in Turkey borrowing even more and that it may have a negative impact on its sovereign credit rating. Named Turkey Wealth Fund with an initial 50 million lira capital injection, the fund will weaken private investments and the budget and will not be a remedy for the country’s low saving rates, according to the report. It could also raise unrealistic growth expectations while risking non-productive investments, it added.

According to Nomura’s Ash, it will be interesting to see how this fund works. “Obviously Turkey has no oil wealth, so this will be a little unusual in terms of its format. I guess the line is to deposit state holdings or assets in this entity and then leverage up to try and stimulate growth. Perhaps this can be used to bring in FDI. It is thinking outside the box, and I guess Turkey needs this to support growth,” Tim Ash, the head of the central and eastern Europe, Middle East and Africa desk strategy at Nomura, tells The National.

The former Turkey central banker and economist Ugur Gürses says such a fund may hurt fiscal discipline and open the path for taking out foreign loans with damaging interest rates. “Such funds are understandable in large oil producers like Saudi Arabia, Norway and Qatar but Turkey has growing current account deficit and should exert its resources to close this gap first,” he warns.

The fund was also criticised for being allegedly exempt from independent audit and capital market fees.

On Tuesday, Turkey’s finance minister Naci Agbal defended the fund, saying it will be “fully transparent”.

He said the fund will operate in compliance with institutional management rules and laws.

The fund will also be considered for finance for such mammoth infrastructure projects as the new international airport in Istanbul, although the government disclosed no such intention so far.

The fund is expected to generate 1.5 per cent annual growth over the next decade and can be increased to as much as US$200n in the long term, government sources said last week.