Economic Update

Of Strengths and Weaknesses

Turkey | 24 Aug 2007

Even the most robust ship can be buffeted by turbulent waters. Analogous to the Turkish economy, economists hope that global market volatility over a US-sparked credit crunch will not turn unbearably sour, triggering greater panic amongst short-term investors. While suffering from a number of structural economic vulnerabilities, Turkey's increased strength and resilience should help prevent turbulent global markets from breaching the decks and flooding the hull of the national economy. Insiders say that the net outflow from the stock market - following the global squeeze on credit - was limited to $200m last week, for a stock market worth an estimated $70bn.

Hot money, that is, funds or money that can rapidly be transferred from Turkey to benefit from favourable exchange rates and trading conditions, remain a concern. In July 2007 the overall level of foreign money in the Turkish market broke a new record, reaching $99.3bn - a $50.2bn increase from the previous year, according to Ata Invest. Of this, $35.4bn constituted Treasury bills and bonds, with $58.3bn invested in stocks.

"Even if 10% leaves, it will adversely affect the market sentiment. So there is vulnerability," said Hakan Aklar, chief economist at AK Securities.

"Bond and equity stocks of foreign investors jumped to $94bn at the beginning of August 2007 from $28bn at the end of 2004. Such a huge stock indicates potential risk, when sentiment of foreign investors turns negative," stated a recent report by AK Securities.

That said, a massive sell-off is unlikley since, in the absense of willing buyers, the Istanbul Stock Exchange does not allow for massive flight.

"In the presence of volatility, I think that Turkey is one of the greatest safe-havens...Investors can not exit the market easily,' Ahmet Yildirim, general manager of Yapi Kredi Yatirim, told OBG.

In any case, portfolio investors that enter Turkey tend to be prepared for risk and are aware of local conditions.

None of this detracts from Turkey's largest economic thorn. The size of the current account deficit ranks as the greatest structural economic concern, equivalent to $31.7bn - or 7.9% of gross domestic product (GDP) - by the end of 2006, according to the undersecretariat of Treasury. National import requirements have much to account for, with 97% of gas and 90% of oil piped in from neighbouring states. High global oil prices have increased the burden on government coffers. While in 2002 Turkey imported $9bn worth of fossil fuel and oil-based products, the country footed a bill worth $29bn in 2006, Minister of State Ali Babacan told OBG in early 2007. Capital goods also account for the red, with imports hitting $24bn last year, compared to $8bn in 2002.

In the minds of investors, the gap in the balance of payments has placed Turkey amongst the most exposed emerging markets around. But while economists expect the current account deficit to hit an estimated $34bn by the second half of 2007, its proportion as a percentage of GNP is expected to decrease by the end of the year.

However, this has not defused concerns over the level of private sector borrowing. According to AK Securities, the external debt stock of the private sector as a percentage of GNP increased from 14.2% in 2004 to 19.5% in the first quarter of 2007. The significant exposure of the non-banking sector heightens the risk of the Turkish economy being rocked by external shocks.

But the economy also enjoys strong fundamentals. Despite the strength of the Turkish lira in 2006 and into 2007, the government has made good headway in its export-led growth strategy, helping to slow the increase in the current account deficit.

"The export-led growth structure helps Turkey to improve external balances... restrained domestic demand has contributed to the disinflation effort," said Hakan Aklar.

The quality of current account financing has also increased, with greater diversification away from short-term financing. Before 2002, foreign direct investment levels averaged $1bn per year, whereas in 2006 the flow hit $20.2bn, according to Ali Babacan - some testimony to the level of confidence in the economy. The government also boasts a high primary surplus - 6.5% of GNP in the first half of 2007.

In line with the government's positive macro-economic achievements since first assuming office in 2002, Turkey's net public debt has receded to 44.8% of GDP at the end of 2006 from 78.4% at the end of 2002, according to AK Securities.

While the Central Bank (CBT) has maintained flat interest rates since July 2006 (allowing for excess capacity in the economy) it is also sitting on sizeable foreign exchange reserves, placed at $95bn as of August 2007. After rebounding from a run on emerging markets in May 2006, the public sector and CBT appear to be prepared for external shocks.

Yet, risk remains. Global market vulnerability and sensitive investor sentiment, combined with the risk - no matter how slight - of intervention from the military during the course of the presidential elections, could cause a scare and blow the economy off course. Investors hope that the AKP's candidate, Abdullah Gul, will win the presidential vote in the third round of voting with little political commotion, as many economists now project.

Chapter Summary