Turkey has spent the last decade trying to maximise the potential of its geographical position and ability to expand its economy with export-led growth. While this has been hampered by a heavy dependence on imports and a bulging current account deficit, the country has made great strides in growing trade and diversifying markets.
With strong domestic growth and a sense of economic stability following the difficulties of the 1990s and the 2001 banking crisis, the country has been able to radically transform the investment environment, garnering record numbers for foreign direct investment in the last 10 years.
Trade Deficit
In many respects 2014 was typical of Turkey’s recent trade performance. The country ran a significant trade deficit as it has in successive years since the global financial crisis. In 2014 exports grew by 3.9% to $157.6bn, while imports totalled $242.2bn, a drop of 3.7%. As such the republic is running a trade deficit of $84.5bn, or around 10% of GDP. This is the result of a multitude of factors. Even in the pre-crisis years when Turkish exports were growing in double digits, the country was running a large trade deficit. In 2007, for example, exports grew by 25.4% to $107.3bn, but the deficit was still a sizeable $62.8bn. This is indicative of the structural limitations of the economy, with export and domestic growth and production highly reliant on imports. Indeed, according to the World Economic Forum’s “Global Enabling Trade Report 2014”, intermediate goods accounted for 61.3% of total imports in 2012, with industrial supplies (primary and processed) accounting for 45.5% and parts and accessories accounting for 10.8%. In such circumstances, the country has to run a large foreign trade deficit and current account deficit to achieve strong growth.
Indeed, since 2006 the external trade deficit has only been below 9% of GDP once, in 2009, when the economy contracted by 4.8%. Similarly, the current account deficit has only been below 5% of GDP once in the last seven years, again in 2009. The structural problems of the economy are also exacerbated by Turkey’s dependency on energy imports.
In 2012, for example, net energy imports accounted for 73% of energy use in Turkey, according to the World Bank. Turkey’s energy import bill stood at $55.9bn in 2012, or 23.6% of the total value of imports. This has been a chronic problem for the country and a significant contributing factor to its balance of payments problem.
Energy Imports
As the government targets becoming one of the top-10 largest economies by 2023, the demand for energy is likely to increase. The government is adopting a range of measures to lessen the country’s energy dependence and cut the import bill. The primary policy is to boost domestic energy production through the roll out of a nuclear energy programme. The government plans to bring the private sector on board to build three nuclear plants in the next decade, cutting some $7.2bn from the annual natural gas bill.
The government has already signed contracts with a Russian firm, Rosatom, and a Japanese-French consortium of Mitsubishi Heavy Industries, Itochu Corporation and GDF Suez for the construction of the first two nuclear plants on the Mediterranean and Black Sea coasts, respectively.
The construction of the country’s first nuclear plant near Mersin on the Mediterranean coast started in April 2015. Initially expected to begin generation in 2019, the Akkuyu plant is now likely to start operations by 2020, while the second facility in Sinop is expected to be operational by 2023.
However, the current account deficit is narrowing: the 2014 deficit decreased to $45.8bn from $65bn in 2013, according to the Turkish Central Bank. In its “World Economic Outlook April 2015” report, the IMF estimates Turkey’s ratio of current account deficit to GDP to narrow to 4.2% of GDP in 2015 from 5.7% of GDP in 2014 thanks to a substantial fall in the cost of energy imports. As an energy importer, lower oil prices have benefitted Turkey and are positively impacting the current account. The price of Brent crude was at $45.25 per barrel in April 2015 – its lowest level since March 2009.
Gold Trade
In addition to energy imports, the other major distorting factor for Turkey’s trade balance has been gold. In 2012 net gold trade recorded a surplus of almost $6bn on the back of a deal to send gold to Iran as payment for natural gas and oil imports. However, as the US closed a loophole in its sanctions regime against Iran in the second half of 2013, these exports declined. Indeed, in 2013, Turkey recorded a net gold trade deficit of almost $12bn, as it replenished gold stocks while taking advantage of cheaper prices in the international market.
In 2013 gold imports reached some 302.3 tonnes, more than double the level one year earlier when imports totalled 120.8 tonnes. This massive fluctuation in gold trade had a substantial impact on the country’s trade deficit for 2013. Indeed, excluding the gold trade, exports grew faster than imports in 2013. Furthermore, excluding energy and gold imports, Turkey’s current account deficit looked much more healthy, standing at less than 1% of GDP. In 2014 gold imports declined sharply, totalling 130.9 tonnes, according to data from Borsa Istanbul.
Target Markets
The prospects for foreign trade and the current account in 2015 look promising. The IMF says Turkey’s economic growth is likely to increase to 3.1% in 2015, up from 2.9% in 2014, as consumption will be boosted by lower energy prices. Turkish exports have also become more competitive as a consequence of a depreciating lira in 2013-15.
The country’s export growth is likely to be helped by the recovery of its leading target markets. The slow but steady recovery of the eurozone bodes well for Turkish exports. Although the government has looked to diversify Turkey’s export markets, the EU as a whole remains a critical part of the republic’s trade performance, accounting for 41.5% of total exports in 2013 (down from close to 60% a decade earlier) and 43.5% in 2014. The eurozone is showing clear signs of recovery, growing 0.3% in the fourth quarter of 2014 as a whole, while its largest economy, Germany, expanded by 0.7%. The European Commission is forecasting growth in 2015 of 1.3%, which would be the area’s best outcome since 2011 when it grew by 1.6%. Meanwhile, the European Central Bank has raised its GDP forecasts for 2015 and 2016 and projected 2.1% growth in 2017, the first time in a decade that it has forecasted growth above 2%.
This augurs well for Turkey, especially considering the impact the fallout from the Arab Spring has had on its other main export market. Turkish exports to the Near and Middle East declined by 16.1% to $35.6bn in 2013 and to $35.4bn in 2014. As such, the region’s share in Turkish exports fell from 27.8% in 2013 to 22.5%. Excluding this unstable region, Turkey is well placed to grow exports across all regions. The country’s leading exports are automotives, textiles and chemicals. One potential growth market could be Iran. Given the loosening of the US sanctions regime, Turkey’s neighbour could realise its potential as a destination for Turkish goods. Historically, Turkish exports to Iraq and Iran have largely run in parallel. However, since the introduction of sanctions, their paths have diverged. Iraq is now Turkey’s second-biggest export market after Germany, with exports reaching some $10.9bn in 2014, while Iran ranks tenth with around $3.9bn worth of exports, according to TurkStat.
Foreign Investments
Beyond the general trade environment, the government is also looking to bolster foreign direct investment (FDI) to fund the current account deficit. An uptick in FDI could help the country to reduce its dependence on intermediate imports and thus reduce the trade deficit in the manufacturing and industrial sectors. It can also help the country to develop higher-value products and transfer knowledge to the local economy.
Turkey has certainly improved its ability to attract foreign investment in the last decade. Put simply, between 2004 and 2014, the country attracted 8.5 times more FDI ($123.7bn) than it did in the whole of the previous 80 years. And yet since a peak of $22bn in 2007, Turkey’s FDI performance has been stuttering. In 2013 the country received $12.4bn in FDI, a decrease of 6% on the previous year, according to the central bank. However, 2014 saw a slight improvement to $12.5bn. The country’s sluggish performance is the result, to some extent, of a weak export environment. This is particularly true in the automotive sector, a significant recipient of FDI, and an industry that exports the majority of its products.
With Europe gradually recovering from its long recession, the opportunities for export-led FDI growth in Turkey are improving. Indeed, for the first time, Turkey was ranked as one of the most promising economies for FDI between 2013 and 2015 on the UN Conference on Trade and Development “World Investment Report 2013”. The government has certainly taken great strides to attract more FDI. In April 2012, for example, then-Prime Minister Recep Tayyip Erdo ğan (now the president) announced a package of measures to incentivise investment including export tax exemptions, value-added tax exemptions and refunds, employment insurance support and interest rate support.
Turkey has also been growing its base of special economic zones with 59 technology development zones (40 of which are currently operational) aimed at bolstering research and development innovation across the country, 289 organised industrial zones (212 of which are operational) and 20 free zones (of which 19 are operational). All of these zones offer investors a range of exemptions and incentives to support investment.
Obstacles
However, challenges remain to boost FDI in the country. The corporate tax rate has been brought down to 20% from 35% and foreign investors are subject to exactly the same regulations, levies and laws as domestic companies, however, taxation remains a major concern for investors. According to EY’s Turkey Attractiveness Survey 2013, corporate tax remains an issue for potential investors.
Turkey ranks 56th out of 189 economies for paying taxes in the “World Bank Doing Business 2015” Report. The bureaucracy surrounding tax payment, as well as payment rates, is preventing the country from a higher ranking. In August 2013 the Revenue Administration altered its interpretation of build-operate-transfer (BOT) agreements, effectively meaning that investments made in a BOT project could now be subject to taxation.
Fırat Yalçın, a partner at Pekin & Pekin, an Istanbul-based law firm, told OBG that the tax ruling is a significant change in the taxation of BOT. “The ruling is likely to significantly increase the tax burden of investments made through BOT, and although the tax burden may not have any major effect on the government budget, considering that investors will include such cost items when bidding for public-private projects, it will impact the cost of investment to the government,” he said.
Higher interest rates since January 2014 may also have a negative effect on FDI given that it increases the cost of money. While this is unlikely to deter investors, coupled with the general economic environment, it may lead to a wait-and-see attitude. Indeed, the interest rate environment is likely to have an impact on large-scale infrastructure projects in the country, financed by private and foreign capital predominantly on a BOT basis.
Outlook
However, there is substantial potential for FDI in the country. Turkey’s location, population and longer-term growth potential make it an attractive option. In the short term, the weaker lira will also offer opportunities, in terms of establishment costs and export potential for foreign investors.
Indeed, the coming year is likely to see Turkey’s trade deficit shrink as a number of factors converge to boost exports. The return of growth to Europe, the growth potential of the Iranian market, a weaker lira and weaker domestic demand all point to an upsurge in exports, while imports are likely to decline.
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