Turkey, growing downside risks

The economy is expected to grow 6.7% this year in Turkey, followed by a slowdown to 4.5% in 2012. Inflation is forecast to remain high next year: at around 6%.
Analisis Credito y Caución
Madrid - 07-dez-2011

The general elections of June 2011 delivered a clear victory for the religiously conservative, pro-EU Justice and Development Party [AKP]. This result means the AKP can again rule with an absolute majority for the third consecutive term. In recent years, the AKP government has been successful in gradually curbing the armys political powers and increase democratic control over the courts.

The ongoing political strife is fuelled by structural social and economic conflict between the so-called `white Turks´ - consisting of the secular establishment, including the military and the urban population in the western regions - and the `black Turks´ whose supporters originated in rural Anatolia, and many of whom have, over recent decades, migrated to the major cities. This new class can be described as pious and entrepreneurial and its members are AKP supporters. These black Turks have steadily gained economic and political power at the expense of the old secular elite, who are now afraid of losing ground.

The AKP will retain its firm grip on power until the next presidential election due in 2014 and general election in 2015, thanks to its absolute parliamentary majority. However, the domestic situation will remain complicated as a result of ongoing tensions and lack of trust between the AKP, the secular establishment and the army.

EU membership out of sight?

Accession talks between Turkey and the EU have been effectively on hold since December 2006, when the EU suspended further negotiations for eight of the 35 chapters until Ankara opens its ports and airports to Greek Cypriot traffic. Other major obstacles to EU entry are the Kurdish issue, the need for reform, and the covert resistance of some of the EUs major states to Turkish entry.

Because of this slow progress, the formerly widespread popular support for EU accession is declining. Furthermore, some important political groups still lack a consistent stance towards EU entry. Government now focuses more on relationships with the Middle East and Central Asia: aiming to strengthen political and economical ties with the countries in those regions.

Turkish EU membership does not seem likely before 2020 at the earliest. While progress on the Cyprus issue is possible in the medium term, there remain many other hurdles such as human rights, freedom of religion, and the Kurdish question. EU members remain divided over Turkeys membership, and in Turkey itself doubts about the benefits of EU entry [related to the costs] are rising, while foreign policy has shifted its focus away from the EU and towards the Middle East and Asia.

Increasing sings for an economic overheating

After the Turkish economy shrank by 4.8% in 2009, it recovered rapidly, with year-on-year GDP growth of 8.9% in 2010, driven mainly by domestic demand. This upswing accelerated even more in 2011, with economic growth of 11.6% in Q1 and 8.8% in Q2: clear signs of economic overheating. This boom has been driven by low interest rates, public sector spending ahead of the June 2011 general elections and a liquidity boost propelled by foreign capital inflows and bank credit growth. In Q2 several industries experienced impressive growth figures: construction [13.2%], wholesale/retail trade [13%] and the financial sector [14.3%]. Industrial production saw a remarkable increase in the first half of the year with an average rate of 7%. Capacity utilisation also improved to 76% in August  from 73% in August 2010. However, while private consumption and business sector investment have increased sharply, Turkish exports are growing less rapidly.

After increasing to 8.6% in 2010, inflation has decreased somewhat in the course of 2011, but was still high - at 6.15% - in September. Inflation has been driven by a weaker lira [which has increased import costs], strong economic growth and several tax increases.

The banking sector is still strong, with a high capital adequacy ratio of over 18%, high profitability and a transparent loan portfolio that does not involve mortgage products. In line with the business sectors improved performance, non-performing loans decreased to 2.9% in July from 3.6% in July 2010. Bounced cheques, an excellent indicator of payment behaviour because of the common use of cheques in Turkey, decreased by 44% in the first eight months of the year.

Public finances deteriorated sharply in 2009 with a deficit of 5.5% of GDP, on the back of lower tax income, together with subsidies and public expenditure aimed at boosting economic activity. However, fiscal consolidation has reduced the budget deficit to 3.7% of GDP in 2010 and 2.2% in 2011. Public sector debt is moderate [43% of GDP] and the primary budget [i.e. excluding interest payments on outstanding debt] has shown a significant surplus at the end of H1 of 2011. In general, the pace of structural reform [to social security, the banking sector and tax administration] is still too slow. However, efforts towards privatisation have shown good results.

Large foreign capital inflows have given Turkey a liquidity boost. To discourage this strong inflow in Turkish lira denominated assets, the Central Bank has taken pro-cyclical measures by easing monetary conditions and lowering the one-week repo rate [from 6.25% to 5.75% in August 2011]. However, instead of dampening domestic overspending, this monetary policy has fuelled economic growth even more. That said, in order to strengthen the lira and to cool down domestic demand, in October 2011 the central bank increased the overnight lending rate from 9% to 12.5%.


The economy is expected to grow 6.7% this year, followed by a slowdown to 4.5% in 2012. Inflation is forecast to remain high next year: at around 6%.

While Turkeys overall liquidity and solvency situation is reasonable, there is a risk that the current economic overheating will end up in a hard landing. The massive current account deficit [forecast to rise to 10.5% of GDP in 2011 and to lower only slightly in 2012: to 9% of GDP] and the recent depreciation of the Turkish lira could well lead to domestic economic growth going out of control.

As much of the current account deficit is financed from volatile short-term investment, any shake-up of financial markets may trigger a massive withdrawal. Currently investor confidence is tarnished by the high current account and the Eurozone debt crisis.

A sudden fall in the lira exchange rate cannot be ruled out, making foreign debt service more expensive. This, together with a tighter monetary policy, would lead to a much higher non-performing loans ratio for banks, with more private sector defaults. Turkey is noted for boom and bust, i.e. years of high GDP growth followed by  recession, and therefore care must be taken in assessing business opportunities there.

However, the central bank has reacted: mid-October it used its foreign currency reserves for a direct market intervention in order to stem against the lira weakness, which depreciated more than 15% against  the US$ in the first nine months of 2011. End of October the central bank took additional measures to increase effective interest rates in order to stabilise the currency and slow down credit growth.

Sector performance: general upswing, but textiles and plastics are still suffering

Almost all sectors have benefited from the economic recovery. Automotive is Turkeys second largest export sector and an important customer of several other industries. Production in both vehicle and spare parts segments has increased significantly in 2010 and 2011, due mainly to foreign demand. Increased demand from the automotive, machinery and construction industries, as well as the overall economic growth, has helped the steel/metals sector. Pharmaceuticals remain a stable and strong sector.

However, textiles are still particularly vulnerable, due to a combination of excess capacity, lack of branded production, low capitalisation, decreasing domestic and export demand, competition from the Far East, and a non-performing bank loans ratio of around 10%. In the chemicals industry, the plastics subsector faces similar structural problems, contributing to its problems.

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