Carlos Hardenberg of Mobius Capital Partners argues that Turkey must return to it’s initial recipe of reform and prudence
When I moved to Istanbul in 2006, an old friend who had lived in Turkey for decades shared an important observation with me: trying to fully understand the country is like drinking the local Raki. Initially crystal clear, the drink is then mixed with water which makes it turn cloudy. Drinking a few glasses of this tasty spirit (a must with a fresh sea bass) will cause you, at the very least, some confusion.
Similarly, the more one tries to understand Turkey, the less clarity one finds. I left Istanbul two months before the attempted military coup in 2016. Since then I have visited the country regularly, and so have observed the clouds casting over the positive developments I witnessed in the ten years following my arrival.
Since 2010, Turkey’s economy has experienced an almost unprecedented expansion. Its GDP has grown from $273bn in 2010 to $851bn in 2017, making it one of the largest emerging economies in the world. Disciplined fiscal policy and limited external public debt led to lower inflation and more affordable interest rates. Millions of people escaped poverty, with per capita income soaring from about $9,000 in 2000 to about $27,000 today. From airports and roads to schools and hospitals, infrastructure boomed.
At the same time, the country was making great progress in bringing together highly diverse cultural groups. Strides in Kurdish peace process led to new rules and regulations that expanded tolerance towards minorities.
Due to this investor-friendly climate, Turkey became a market darling. Its stock market boomed, and the banking sector was regularly described as the most robust and healthy in the world. As a result, private equity investors regularly flocked to purchase billions of dollars’ worth of Turkish assets. In fact, foreign direct investment reached a peak of over $20bn in 2006 and 2007. In other words, the economy was red hot, leading Turkish conglomerates in turn to snap up prized assets around the world.
Sadly in recent years the tensions between the predominantly western-oriented so-called Kemalists and the vast population on the countryside leaning towards a more religious lifestyle have intensified. Power has shifted from the Kemalists and the military to a new religious business and political elite that are much less interested in preserving the secular values espoused by Mustafa Kemal Ataturk, the founder of the Turkish Republic.
As this shift has taken place, the economy has overheated, with Turkey witnessing the second-largest private debt to GDP build up since 2009 second only to China.
Following the attempted military coup in 2016, the country has seen its parliamentary system change radically. Its checks and balances have been eroded as power has shifted towards an executive presidential system with one man at the head, Recep Tayyip Erdogan.
After making his inexperienced son-in-law finance minister while simultaneously removing Mehmet Simsek, a former Merrill Lynch banker, Erdogan gave himself sole power to name the new governor of the Central Bank.
Similarly, the legal system, police and media are now essentially controlled by the government. A report prepared by the World Justice Project sees Turkey ranked 101st among 113 states in the Rule of Law Index and 107th for fundamental rights, including freedom of the press. Despite the condemnation by the European Court of Justice for the incarceration of opposition politicians, many highly respected civilians such as the businessman and philanthropist Osman Kavala remain in jail without a trial.
Turkey’s shocking U-turn has resulted in a loss of credibility and destruction of investor confidence. Turkish lira lending rates have increased sharply to above 35 per cent. The Turkish lira has lost around 70 per cent of its value against hard currencies over the past ten years.
With Turkey’s foreign debt at $466.7bn (as of June 2018) or 54 per cent of GDP, the weak currency poses a high risk in terms of hard currency interest payments. Inflation also remains high at around 20 per cent. And while the central bank has finally raised interest rates, the response came very late. Turkey’s economic growth slowed sharply in the third quarter of last year to 1.6 per cent.
In line with this, the IMF has revised its growth prediction for Turkey for 2019 from 4 per cent to 0.4 per cent. This compares to 7.4 per cent in 2017, and an estimated 3.5 per cent for 2018. And while some slowdown is welcomed, there now looms the threat of recession.
Despite the political clouds cast in recent years, Turkey could return to a path of success. To do that, it is crucial that the country finds its way back to its initial recipe of reform and prudence to ensure that ideas and talents remain onshore. It must rapidly correct its course of dramatic polarisation and allow a new generation of leaders to emerge. Turkey soon needs to commit to a credible macroeconomic stabilisation program and pragmatic monetary and fiscal measures to regain investors’ confidence.
The country has all the ingredients needed for sustainable growth. It has some of the most powerful and agile business groups in the emerging-market universe. Many of these companies are well prepared for volatile times and have, for the most part, been careful about exposure to foreign currency debt, especially in relative terms.
With a weaker lira, Turkish companies will be in a good position to grab a bigger share of the exports market. The structural trade deficit is already narrowing. At the same time, the currency crisis makes investments in Turkey relatively cheap for investors. In fact, 2019 has bode well for the Turkish stock market, which climbed over 16 per cent in January in one of the best starts to the year in some time.
And so as I enjoy a cloudy glass of Raki with friends in Istanbul, I hope that the economic and political clouds will clear over Turkey. The country and its people deserve it.
