DEG: Turkey – Growth Market and Bridge to the East

Author: Alexander Klein

Turkey was long considered especially promising in the group of emerging-market countries. However, political developments and Turkey’s susceptibility to recent turmoil in financial markets means that the perception has now shifted. But which is the correct impression? Do current political events simply shroud the country’s economic potential? It’s a fact that many companies continue to operate successfully in Turkey, and are consolidating their position in the domestic market, as well as in the East. And yet, the development of the past years suggests a differentiated view needs to be taken of the opportunities and risks. 

Following on from the successfully marketed concept of the BRIC states in 2001, Goldman Sachs presented the “Next Eleven” in 2005, as the “successor” to these booming emerging-market nations. Turkey was part of this group, besides countries such as Nigeria and Egypt. The reform economic policies of Recep Tayyip Erdogan, the prime minister elected in 2003 and former mayor of Istanbul, proved popular, and the country seemed to be well on the way to leaving behind the impacts of 2001’s economic crisis, as well as the fiscal austerity imposed as part of the IMF-assistance and structural reforms. The foundations seemed to be laid for Turkey to join the ranks of the industrialised nations.

Yet the euphoria has now subsided. Observers are perturbed by Erdogan’s authoritarian behaviour in particular, for instance his handling of the Gezi protests in the summer of 2013, or his reaction to allegations of corruption against members of government at the start of 2014. And still, Erdogan won the absolute majority in 2014’s presidential elections.

“The underlying economic conditions are still promising: the economy, with its population of approximately 80 million and a GDP of almost $900bn, is a heavyweight, not only in its own region.”

The economy too, is worrisome for several observers. The announcement by the US Federal Reserve to review its current monetary policy in the medium term, led in 2013 to capital flight from emerging markets. States reliant on foreign capital bore the brunt of this including Turkey, with its currency depreciating substantially during this period. In the end, Turkey was even considered as one of the “fragile five”.

The focus of this concept, marketed by Morgan Stanley at the end of the summer of 2013, was on the major emerging-markets, capital market relevant nations with a high susceptibility to capital outflows. Brazil, South Africa, India, and Indonesia joined Turkey in this group. In view of this development, the question is whether the previous euphoria regarding Turkey was excessive, and how to assess the situation.

The underlying economic conditions are still promising: the economy, with its population of approximately 80 million and a GDP of almost $900bn, is a heavyweight, not only in its own region. GDP growth has now evened out at about three to four per cent annually due to monetary and fiscal countermeasures after a short-term slump in economic output during the global financial crisis 2008/2009, and the temporarily increased volatility caused by the above mentioned global capital outflows from emerging-market countries in 2013.

This growth level is, in fact, lower than in the years preceding the global crisis, but on the other hand it is more sustainable. After years of credit-driven growth in the recovery phase, a few years of consolidating are now on the agenda, even though, during this “breather”, Turkey is still faring considerably better than the EU countries.
Turkey has a demographic advantage compared to many industrial countries, due to its young and frequently well-educated, growing population. In the past ten years, a strong middle class has emerged and the previous disparity in income between urban and rural areas has diminished.

Turkey also now has a much better transport and energy infrastructure than a few years ago. Turkish entrepreneurs have played the economic reforms to their advantage, and alongside the versatile small and medium-sized enterprises have generated successful international groups which are well represented in many sectors today.

For instance, Turkey has now grown to become the second largest steel producer in Europe. International consumer goods manufacturers, such as Beko, have long been expanding beyond European borders, and the shipbuilding industry, which has fared well since the start of the 20th century, is market leader in a number of niche segments.

The services sector was subject to strict regulation in the past, but still developed successfully in the major industrial centres. Alongside tourism, banking should also be highlighted. Additional impetus for growth and innovation was generated by further opening up the service sector.

In addition to the domestic market, the export business offers opportunities. Turkey would also benefit from an improved economic climate in the EU countries, as the EU is Turkey’s most important trading partner due to its membership in the EU Customs Union. About 40% of Turkish exports, valued at around $60bn annually, are destined for the EU. Turkey’s most important trading partners within the EU are Germany, Great Britain, and Italy. In 2014, Germany delivered goods to Turkey amounting to almost EUR20bn; mainly cars and car parts, machinery, and chemical products.

However, Turkey’s membership in the EU Customs Union also has a downside. It obliges the country to lower its import duties towards third countries with which the EU has negotiated bilateral free trade agreements – without automatically benefiting from customs-free market access itself. As Turkey is only a member of the customs union, it is not party to the bilateral EU agreements and is therefore compelled to negotiate separate agreements with these countries.

Against this backdrop, Turkey is concerned about the free trade agreement being discussed between the EU and the USA, which would not only open the door for competitive American companies to Turkey’s European sales market, but to Turkey itself too – without automatically granting permission for Turkish goods to flow in the other direction. As a result, Turkey is drawing on its geo-strategic position to build up additional economic ties and in doing so, focus on the countries in the Middle East, as well as those located on the Silk Road all the way to Asia.

Iraq, for example, is Turkey’s largest bilateral trading partner after Germany. Ten years ago, the country’s share in Turkish exports was less than three per cent. Now, around seven per cent of Turkish exports find their way into Iraq. The Shanghai Cooperation Organisation (SCO), a regional organisation for economic and military collaboration, is a further example of additional markets beyond the EU. The members include China, Russia, Pakistan, India, and Iran some of whom only have observer status. While Turkey is, at present officially a dialogue partner, in 2013 it applied for the next highest level which is observer status.

All in all, Turkey shows great economic potential, but is more volatile in comparison to a number of European countries. Many foreign companies use this potential not only through trade relations, but also through direct investments. In doing so, companies have an eye both on the large Turkish domestic market and the region as a whole. In the latest survey of the International Investors Association (YASED) around a third of the multinational companies polled stated that they have a local headquarters for working in the region based in Turkey.

The changing regional source of direct investments also mirrors this regional diversification. Accordingly, in 2009, direct investments from the EU amounted to more than three-quarters of the annual overall investment volume. This share is now declining in favour of companies from Asia and the Middle East.

Alongside changes in the share of source country, the increasing importance of services has also changed the sectorial distribution, because it has been recognised that there is potential besides the manufacturing industry. For instance banks from China, Japan, and the Gulf States have recently expanded their presence in Turkey through investing and opening branches.

These developments and the strategic alignment of many multinational companies clearly highlight that Turkey’s potential as a growth market and a bridge between the East and the West is still important. But although the potential in the dynamic environment in the markets on Europe’s doorstep should not be underestimated, neither should the risks be.

The International Monetary Fund (IWF) recently cautioned Turkey about its susceptibility to external shocks due to its dependency on foreign flows of capital for financing its chronic current account deficit, and at the same time, urged the country to instigate desperately needed structural reforms. Increasing Turkey’s competitiveness is important in order to avoid remaining in the “middle-income trap” and achieving a growth level of over 5% p.a. in the medium to long term.

Turkey’s further economic success will therefore hinge on whether the recent doubts regarding rule of law, and for example the independence of the central bank, prove to be justified, or not, and the government is prepared to push forward on further economic reforms after the parliamentary elections in the summer of 2015.

Despite these risks, Turkey remains a growth market in which activities can be carried out successfully supported by experienced partners. An experienced financing partner for investments in future markets is DEG – Deutsche Investitions- und Entwicklungsgesellschaft mbH, which has a representative office in Istanbul.

About DEG

DEG, a subsidiary of the KfW development bank finances investments of private companies in developing and emerging markets. As one of Europe’s largest development finance institutions, it promotes private business structures to contribute to sustainable economic growth and improved living conditions.

About the Author

Mr Alexander Klein is the senior macro economist in the Corporate Strategy and Development Policy Department at DEG – Deutsche Investitions- und Entwicklungsgesellschaft mbH.