Turkey’s economy is threatened on many fronts. A row with Russia and the prospect of the US Federal Reserve raising rates have coincided with President Tayyip Erdogan’s increasing politicization of the economy and bad governance. This could prove a toxic cocktail given the private sector’s high debt.
Turkey’s cost of capital is rising. The government’s 10-year dollar bond yield was 5% on Dec. 4, up from 4.7% a year ago and 4.1% just before Turkey shot down a Russian jet last month, Reuters reported.
The government isn’t to blame for global investors falling out of love with emerging markets in general or, indeed, for what Turkey claims was a Russian invasion of its air space. But many of the risks Turkey is facing are self-inflicted.
Russia’s muscular response to the shooting down of a Russian bomber jet in November already threatens to create economic costs for Turkey. Among the raft of economic sanctions already announced, banning charter flights to the country and other moves to dissuade tourism will be especially damaging. About 3.3 million Russian tourists visited Turkey last year.
The truth hurts now as the country–among the fastest growing in 2011–has plunged into weak growth and high spending.
Tensions with Russia could cost Turkey’s economy $9 billion in the worst case scenario of “zero relations”, Turkish Deputy Prime Minister Mehmet Simsek said on Monday.
The current tension is likely to shave 0.3% to 0.4% off Turkey’s gross domestic product, Simsek added. Russia’s sanctions include a ban on the import of some Turkish foods and a halt on sales of holiday packages, a major blow to Turkish tourism.
Simsek said that the number of Russian tourists visiting Turkey and construction contracts with Russian companies had also significantly reduced.
Turkey should present a “more orthodox” monetary policy, Simsek said, adding that he planned to announce a roadmap for reforms this week.
Politicizing the Economy
As if this were not bad enough, Erdogan has increasingly politicized the economy. After taking power in 2002, he followed prescriptions laid down by the International Monetary Fund in the wake of its last financial crisis.
But in recent years, Erdogan has undermined the independence of the central bank by opposing higher interest rates, so much so that the country has little credibility for fighting inflation which hit 8.1% last month. Meanwhile, the Turkish lira has dropped more than a fifth against the US dollar in the past year, putting pressure on companies that have borrowed in hard currency.
Since the November election, there have been further worrying signs. Ali Babacan, who had been deputy prime minister in charge of the economy and was seen by investors as a safe pair of hands, wasn’t reappointed. His replacement, Mehmet Simsek, is well regarded but not considered a heavyweight. What’s more, Erdogan’s son-in-law, Berat Albayrak, was made energy minister.
Weak Rule of Law
The Turkish president is also becoming increasingly authoritarian. The editor of a leading newspaper was put in jail last month for publishing an article that Erdogan deemed espionage, even though there has yet to be a trial to test the claim. It’s not just freedom of the press that has been curtailed. So has the independence of the judiciary, while corruption is widespread, according to the European Commission.
Instability and weak rule of law is bad for business. There has also been capital flight. Turkey is vulnerable because it has been consistently running a big current account deficit–forecast to be 4.5% of GDP this year by the IMF–and needs foreign funds to plug the gap.
The economy is still expected to grow at about 3% largely because construction and domestic consumption have held up. However, this depends on credit–with households borrowing to buy homes and developers borrowing to build them.
Housing investment is fuelled by rising property prices, and pushes them still higher. But if they stop going up, the debt that has backed purchases could weigh heavily on the economy.
