Turkey’s economic resilience tested as post-Gezi tensions linger

One year after the Gezi Park protests began, Turkey has yet to calm investors’ fears of political risks at home, while external risks such as US Federal Reserve (Fed) monetary stimulus tapering, add to the threat of losing the image it has held for the last decade of being a reliable investment market with sustainable growth. 

The government’s inability to manage the Gezi crisis and attributing almost all market-related problems to protests at home revealed how unprepared it was to contain the damage from the even bigger international market troubles waiting to strike. An alarm bell for emerging markets, the Fed first indicated that it would stop its bond purchases on May 22 of last year, roughly a week before Gezi erupted. Market experts argue that, shocked at the extent of the protests, the government chose to use Gezi as an excuse to buy time while global market troubles were brewing. This also played into the hands of Prime Minister Recep Tayyip Erdoğan, who was eager to maintain the popularity he had built on the country’s economic success.

While the upcoming presidential elections are likely to stir even more instability in the already fragile domestic markets, observers argue that Turkey’s reliance on the flow of foreign investment remains one of its weakest points. All of these factors are exacerbated by uncompromising rhetoric used by some top government officials, making the country appear even more unpredictable to foreign investors who park their cash in Turkey.

“The situation is getting harder for the government to handle and the majority of investors do not like Erdoğan’s harsh political tone,” said Uğur Gürses, a former central banker and newspaper columnist, in comments to Sunday’s Zaman.

Gürses explains that Erdoğan’s continuing criticism of independent financial institutions — most recently the central bank — coupled with existing fears of damage to the rule of law in Turkey have already shaken confidence in the country’s markets. “Worse is yet to come for Turkish markets unless the government tones down its rhetoric and stops interfering in monetary policy,” he adds.

March’s local election results might have been greeted with enthusiasm by foreign investors to Turkey, but economic woes continue. The Turkish lira is still weak, inflation is almost double the central bank target, the current account deficit (CAD) is high and the foreign debt burden on private firms is growing. One good thing is that exports are growing at an encouraging speed and the banks are still strong in assets. Turkey’s CAD narrowed to $60 billion in March, from a peak of $65 billion in December, reflecting stronger export growth and a modest decline in imports.

But exporters are now complaining about the lira’s value and the banking watchdog said last week the sector’s profitability will wane this year.

Gezi saw the death of 6 protestors and at least 1 police officer in harsh confrontations between those on the streets and the police. Erdoğan chose to blame “international plotters” for the demonstrations and this rhetoric worked to unite the pious voters in the Anatolian heartland behind him. He used the same tactics to challenge the Dec. 17 corruption probe that implicated him, members of his family, Cabinet ministers and others, and the result was a victory in the March local elections.

Running out of time for reforms, image shaken

Turkey has been dubbed one of the so-called “Fragile Five” economies along with Brazil, India, Indonesia and South Africa, and the country needs an urgent economic reform package to minimize the negative impacts from both domestic and international fault lines.

International ratings agencies like Standard & Poor’s (S&P) and Fitch highlighted the country’s weaknesses in separate reports this month. Fitch said Turkey remains vulnerable to external shocks. It said the first quarter balance of payments data showed that net capital inflows had fallen to close to zero, leaving net errors and omissions ($6.6 billion) and draw downs on the international reserves ($4.9 billion) to fund the current account deficit of $11.5 billion.

S&P cautioned that the continued erosion of institutional checks and balances poses risks to business confidence and economic stability. “A crowded electoral calendar and an uncertain external environment make many of our forecasts highly contingent on investor confidence in the policymaking framework,” the S&P report said. In a clear warning, S&P further said it may downgrade Turkey’s credit rating if there is an unexpected deterioration in the balance of payments or a decline in economic growth.

In further criticism, Fitch said that social media bans implemented by the government further the impression of an administration that has few checks and balances, and that this is not only a risk to the rule of law but also to the quality of the policy making environment.

Gürses recalls that a September Fed decision to delay tapering gave emerging countries like Turkey some time to boost structural economic reforms but that the ruling AK Party was busy trying to maintain its popularity. “We are close to missing the train [ability to make reforms] and this particularly discourages portfolio investors.”

Tim Ash, an analyst at Standard Bank, refers in a phone interview with Sunday’s Zaman to the split in opinion within the government about central bank policies: “We probably have a bit of a double act at work at the moment. Erdoğan and Economy Minister Nihat Zeybekçi are promoting the ‘high interest rates are bad for inflation’ angle for the domestic audience ahead of the presidential elections, while [Finance Minister Mehmet] Şimsek, [Central Bank Governor Erdem] Başçı and [Deputy Prime Minister Ali] Babacan send a more market-friendly and orthodox line to external investors, saying that the central bank is still serious about inflation.” Ash stresses that Babacan and Başçı are still lynchpins for Turkey’s economic policy credibility, and that any efforts to remove them or force their resignation would be a major blow to investor sentiment towards Turkey. “Investors are already fretting over Babacan’s likely departure from office in 2015 because of the three term rule within the AKP [Justice and Development Party],” he says.

Erdoğan mostly speaks to the domestic audience, however, a bigger concern is his management of financial institutions, particularly the central bank, observers note.

“Most foreign investors appreciated Erdoğan’s handling of the economy over the past decade, as he was mostly pro-business. …But now they [investors] see that his rhetoric is not going to change anytime soon and this is not a good sign,” Ash adds.

Despite this negative outlook, some positive developments also took place. The current political tension in the surrounding region has helped some foreign cash flow to Turkey, one finance market expert who did not wish to be identified tells Sunday’s Zaman. An explanation can be found in the recent credit default swaps (CDS) trading volumes, he says.

CDS act as a kind of insurance for investors who own debt — in this case, debt issued by sovereign nations — against potential default or restructuring.

Recent data released by the Emerging Market Traders Association (EMTA), the emerging market debt trading and investment industry trade group, showed that emerging market CDS trading volumes surged 93 percent in the first quarter of 2014 as investors scrambled to protect fixed-income portfolios because of the crisis between Ukraine and Russia, Reuters reported last week. According to data provider Markit, Turkish five-year CDS have dropped by 50 basis points (bps) to 170 bps last week. That means it costs $170,000 a year for five years to insure $10 million of Turkish debt against default.

Trading of Turkish CDS represented a further third of the increase in sovereign CDS volume, revealing the impact of investor re-weighting out of Russia and into other emerging market sovereigns, the Reuters article explained.

Fitch earlier this month had said: “… high nominal rates, a depreciated lira (offering better value), evidence of an improving current account position, alongside a liquid global market and return of a hunt for yield should still see Turkish local markets outperform.”