Trouble in Turkey

Recep Tayyip Erdogan's careful stewardship of the Turkish economy may well be torpedoed by what has been seen as a ham-fisted approach to the protests
By Ed Attwood
Fri 14 Jun 2013 11:37 AM

It’s 11am, and on the immaculately groomed lawns of the Grand Hyatt Istanbul, young protestors are resting in lines, sleeping off a late night’s work in Taksim Square. Next to them, bemused businessmen emerge from taxis that have negotiated the makeshift barriers thrown up on the roads leading to Istanbul’s main square. None of the hotel staff make any effort to move the protestors on, and it’s obvious why; with the police having pulled back to the shores of the Bosphorus, any attempt to shift the sleeping masses could well result in the roads being closed completely again.

On the short stretch of road between the Grand Hyatt and Taksim Square, the remnants of six public buses lie across the street. Vandalised and covered in graffiti, some protestors are even using the vehicles as dormitories.

In Taksim Square itself, the crowds who have camped out in Gezi Park – which has become the tinderbox for protests against long-serving prime minister Recep Tayyip Erdogan that have swept nearly every major Turkish city – are slowly waking to a deafening rendition of Pink Floyd’s ‘The Wall’. It’s more ‘summer of love’ than ‘Arab Spring’.

If that was the scene in Istanbul last weekend, events took a rapid turn for the worse during the course of last week, with riot police pouring into Taksim Square on Tuesday and Wednesday. By Wednesday morning, at around the time that Arabian Business was going to press, the square had been cleared, although protestors remained in Gezi Park itself.

All this has put has put a large dent in the carefully cultivated image of Turkey as the model of moderate Islamic government, the darling of the West and one of the world’s fastest-growing economies.

This is a country into which foreign direct investment – particularly from the Middle East and North Africa (MENA) region – has been flowing in ever greater portions. The region’s inflows into Turkey combined to provide only 2 percent of FDI in 2001; that figure rose to 9 percent in 2011. In addition, the UAE has been the biggest contributor in recent years. From nothing in 2001, the UAE had invested $7.2bn in Turkey by end-2011, dwarfing the next biggest contributor from MENA, Saudi Arabia’s $1.9bn.

Erdogan’s period in charge of the Turkish economy has produced an even more startling change with regard to the country’s exports. In 2000, 56 percent of Turkish outgoing trade ended up in the European Union (EU), with just 13 percent going to MENA. Twelve years later, the MENA region took 34 percent of Turkish exports, with the EU receiving 39 percent. While much of this trade was related to gold, Turkish trade with the Middle East still rose by 18.9 percent in 2012, year-on-year.

The figures for the year so far are not quite so encouraging. According to HSBC, net FDI flows reached $1.4bn in the first quarter, down from $2.3bn during the same period last year.

“We expect around $10bn of net FDI this year,” says Melis Metiner, an economist at the bank. “Hopefully, Turkey will continue to draw more investment from MENA and Asia, reducing its reliance on Europe. So far, we have only seen an inflow of around $80m from the MENA region in the first quarter.”

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From a relatively standing start, Gulf companies have increasingly seen Turkey as a great place to invest. It is now the world’s eighteenth-largest economy, and although GDP growth sank to 2.2 percent in 2012, that figure is still the envy of most of neighbouring Europe’s battered economies. Better news came in the form of the 3 percent growth in GDP in the first quarter, year-on-year, which was announced last week.

Perhaps Erdogan’s greatest achievement has come in the form of solving the country’s sovereign debt problems. In May, Turkey paid off the last of its loan installments to the IMF, and the public debt-to-GDP ratio now sits at a healthy 40 percent, down from a figure of 70 percent when the prime minister took power.

All this means that deep-pocketed entities from the Gulf – whether private equity houses, state-backed behemoths or sovereign wealth funds – have opted to pour money into Turkey in recent years. That trend has no doubt been helped by Erdogan and his Justice and Development Party (AKP)’s brand of moderate Islam, which contrasts hugely with what now seems like the outdated rules implemented by his forebears, including a ban on headscarves for university students. Erdogan himself is a frequent visitor to the Gulf, turning up at the World Future Energy Summit in Abu Dhabi in January, and the Government Communication Forum in Sharjah in February. He also regularly carries out pilgrimages to Saudi Arabia to perform umrah.

This year alone, Commercial Bank of Qatar has bought a 71 percent stake in Turkey’s Alternatifbank for $460m, while the UAE’s Taqa signed off a $12bn deal to help develop coalfields in the south-east of the country. Other prominent Gulf investors in Turkey include Emaar, Saudi Telecom Company, the UAE’s Landmark Group and Aabar, and Kuwait’s MH Alshaya and the Kuwait Investment Authority.

However, the Turkish economy still has its problems. While public debt has sunk, corporate debt has risen drastically.

“Even though corporate debt is rising from a relatively low level, it has gone up rapidly over the past five years – from 29 percent of GDP in 2007 to 45 percent of GDP in 2012,” says HSBC’s Metiner. “If this trend continues unabated, it would be a concern for the long term.

“One reason why Turkey is currently able to weather recessions with relative ease is that there isn’t a lot of leverage that has been built up in the economy. If this picture changes, the economy would be less resilient to external shocks.”

The jury is still very much out on the question as to how the street battles taking place in Istanbul, Ankara and elsewhere could affect the Turkish economy. Only two weeks old, it’s hard to ascertain exactly how much of an effect it could have on the country’s growth – although it’s clear that many millions of dollars will need to be spent on the clean-up.

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Local shops have had their windows smashed, ATMs have been destroyed and the ubiquitous slogan ‘Tayyip Istifa’ (Tayyip resign) has been spraypainted as high as first-floor level on most of the nearby outlets along Istiklal Caddesi, the city’s most famous retail avenue.

It’s also too soon to say whether tourism receipts have been affected. Turkey is one of the world’s top ten tourism destinations, with nearly 32 million visitors taking in the country’s heady blend of history, culture, beaches and natural beauty during 2012.

Last weekend, souvenir shops and hostels in Sultanahmet – the tourist heart of Istanbul that houses the Blue Mosque, the Haghia Sophia museum and the Topkapi Palace – were seeing the usual throng of visitors from Europe, the US, China and elsewhere. One hotel owner, who asked to remain anonymous, said that business was brisk, although he described the Taksim Square protestors as “a gang of idiots”.

In Beyoglu, curious tourists mingled with the fans of famous Istanbulite football teams Fenerbahce, Besiktas and Galatasaray, who put aside their differences for a day to protest together. And on the edges of Taksim Square itself, elderly American visitors sat open-mouthed in cafes, taking in a grandstand view of the action. Hotels like the Grand Hyatt, closest to the square, have certainly suffered; in an announcement last week, Erdogan himself said that their occupancy levels were down by 80 percent.

The rioting has also hit the Turkish lira, which fell on Tuesday to its weakest level against the euro-dollar basket since October 2011. The Turkish stock market fell by 15 percent in the first week of the protests. But worse could follow. If the rallies in Taksim Square and elsewhere continue, then the effects on the Turkish economy will undoubtedly be more substantial.

“I think the protests can possibly continue indefinitely,” says Oliver Coleman, a MENA analyst at British risk consultancy Maplecroft.  “It’s part of a longer-term dynamic that is starting to develop in Turkey. The AKP is so dominant and the CHP [the main opposition party] is so weak in comparison that really these protests may become the main form of expressing political opposition for some time to come.

“The police may be moving back in again to Taksim Square, but there’s nothing to stop them [the protestors] coming back tomorrow or the next day, or whenever another issue - like the alcohol restriction - comes to the fore again. So this is a sign of the long-term trend, a new dynamic in terms of expressing political opposition.”

So far, none of the major ratings agencies have opted to downgrade Turkey based on what has happened so far, although they have made it clear that should protests continue, then a different view may be taken. “These political disturbances become increasingly credit negative the more they intensify and the longer they continue because they heighten the government of Turkey’s (Baa3 stable) susceptibility to balance of payments risks through reduced tourist arrivals and portfolio investment inflows, an important source of current account funding,” Moody’s said in a report last week.

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Fitch, meanwhile, said that the protests thus far were not a threat to the sovereign’s BBB- rating, although it did point out that “much will depend on how the authorities respond to the protests”. That final remark is telling, and reflects the widespread belief that the prime minister’s lack of a conciliatory tone has helped fuel the fire.

“Erdogan’s rhetoric has been pretty ferocious, and he’s speaking particularly to his support base, but at the same time he’s completely alienating anybody else in the country,” says Coleman.

“That includes a lot of the financiers, companies and conglomerates that have allowed the economic boom to emerge in Turkey over the past decade.”

The prime minister has also attacked what he refers to as speculators – both foreign or domestic investors who have put money into the country in the hope of seeing a profit.

However, many of those same investors have done much to contribute to Turkey’s economic growth as it stands today. Erdogan is treading a fine line here; by alienating investors, he could threaten an economy that is heavily dependent on foreign inflows. But at the same time, he is keen to ensure stability by instituting structural reforms that lessen Turkey’s dependence on imported energy, increase domestic savings and boost the value of its exports.

“Turkey’s reliance on external financing is its biggest vulnerability,” says HSBC’s Metiner. “Because domestic savings are low in Turkey, the country needs to draw investment from abroad to finance its rapid investment and GDP growth. This makes Turkey vulnerable to shifts in risk appetite and changes in liquidity conditions.”

But Turkey’s economic conundrum may not be Erdogan’s responsibility for too much longer. Under the byelaws of his party, he will shortly be forced to resign, putting him out of contention for the next general election in 2015. His plans to amend the constitution and to make Turkey’s presidency an executive role – it is currently little more than a ceremonial position – look to have been torpedoed by the recent unrest.

If the protests are contained, and the government can offer an olive branch to the disparate group of activists, Kemalists, leftists, Kurds and secular Turks, then the economy should stay in rude health. If not, that much-needed FDI could soon wilt. Maplecroft’s Coleman says that the fear of FDI plunging is a real one.

“ We’re only looking at a couple of weeks, so I don’t think the protests will have a long-term impact  [on FDI] at the moment,” he says. “ If these protests do continue, which I believe they will – in one form or another, in various parts of the country – then yes, I will think it probably will have an impact. And Turkey is so reliant on foreign portfolio inflows that this could have a significantly bad impact on its economy.”

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