What will it take for Turkey to regain its coveted position as the darling of emerging markets? In the autumn of 2014, I put this question to the country’s former finance minister, Mehmet Simsek, and his answer was not terribly surprising. Turkey’s GDP grew from $196bn in 2001 to $730bn in 2008, thanks to measures put in place by the country’s ruling AKP under the direction of then-Prime Minister Recep Tayyip Erdogan. At the time, several countries were taking advantage of historically low US Federal Reserve interest rates to borrow money, and develop industries such as manufacturing, construction, and tourism.
For Simsek and other Turkish politicians, the answer to the country’s economic woes lies in its ability to place AKP in a position of uncontested power. They argue the economic growth of the 2000s was in part due to the fact AKP was able to govern relatively without disruption. After last month’s referendum to rewrite the country’s constitution, and grant the executive branch (under Erdogan) new, far-reaching powers and extended term limits, AKP is close to getting its wish. So, is the Turkish economy improving?
AKP’s economic miracle
Following an economic crisis in 2001, the Turkish economy recovered remarkably quickly due to the neoliberal policies of AKP that encouraged an influx of foreign direct investment (FDI); assistance from international bodies such as the IMF; and led to the prospect of EU accession.
FDI Flows into Turkey, 2005-16 ($bn)
AKP has a socially conservative political agenda, and pushed for bold reforms to the Turkish economy that hinged on FDI and the growth of the country’s powerful construction and tourism sectors. While the country has become more religious, authorities have no problem catering to secular tourists.
At the same time, Turkey positioned itself as a regional power open for business with all countries. In the late 2000s, this openness was codified in its famed no problems with neighbours’ foreign policy that saw the creation of political and economic alliances with countries ranging from Israel to Iran. The national airline literally carried this message by growing to serve more destinations than any other airline in the world.
Thanks to these economic and political transformations, confidence in Turkey was restored and it became one of the most attractive emerging markets for investors. However, destabilising political events in West Asia quickly spread to Turkey and have since plagued the country’s economy. At the start of the Arab uprisings that severely impacted the economic environment in West Asia, Turkey was still seen as a political safehaven, but that changed when large anti-government protests shook Istanbul’s Gezi Park in the summer of 2013. The protests quickly spread across the country, with a firmly anti-Erdogan message.
Since then, many investors have fled the country as the Turkish lira continues to weaken and inflation rises steadily. Several terrorist operations, including a Daesh attack on Istanbul’s Ataturk International Airport, have had a severe impact on the country’s valuable tourism industry. And yet, through it all, Simsek and other government officials have continued to argue that once AKP is in a position of virtually uncontested power, it will be able to turn around the country’s fortunes.
Crisis of confidence
Turkey’s political challenges underline just how reliant economies are on stability, especially emerging markets. Part of the miracle of Turkey’s economic success in the 2000s was that the country was remarkably stable at a time when the rest of the region was facing chaos.
While Turkey was able to attract foreign capital thanks to its stability, the Turkish economy was defined by its lack of domestic savings. When political unrest threatened economic stability after the Gezi Park protests, domestic savings all of a sudden became an issue no investor could avoid. As prime minister, Erdogan was even perceived as overstepping the mandate of his office by pressuring the Turkish Central Bank not to raise key interest rates.
Recent figures from the Turkish Central Bank demonstrate the pivotal role domestic savings continue to play in the health of the economy. At the end of February, Turkey’s external assets came in at $217bn, but its debt was more than $589bn, which corresponds to about 43.5% of the country’s GDP. Moreover, Turkey is one of the riskiest countries in the world for credit default swaps or risk premiums. Turkey’s large current account deficit also does not appear to be changing anytime soon. According to recent estimates released by the Turkish Statistical Institute, the country is running a $32.5bn current account deficit equivalent to 3.8% of GDP.
Can interest rate turn the economy around?
Throughout Turkey’s recent political instability, two camps _ economists at the Turkish Central Bank and AKP politicians, including Erdogan _ have emerged over the question of the central bank’s role in reversing the country’s economic fortunes. The central bankers advocate raising primary interest rates in a bid to attract foreign investors to increase FDI and buoy the value of the Turkish lira, which hit at an all-time low in 2016 against the US dollar.
However, the independence of the central bank has been overshadowed by pressure from Erdogan not to raise rates for fear that any increase would adversely affect consumer spending (and anger voters). The stalemate between these branches of government, however, is exacerbating the problem of investor confidence. The longer the central bank waits to make significant interest rate changes, the higher the interest rate hike will have to be to stabilise the economy.
Turkey’s Inflation and Interest Rates, 2008-16 (% GDP)
Tourism to the rescue?
On the back of the expansion of Turkish Airlines, tourism became a critical factor in the country’s economic success of the 2000s. Istanbul and towns along the Turkish coastline became international destinations as the country promised history, a secular attitude, safety, and value for money. However, as violence from the war in Syria spilled over in the form of Daesh attacks, and internal fighting continued, tourism rates fell off a cliff. In 2016, the number of tourists visiting Istanbul dropped 26% to roughly 9m, compared to 2015 figures.
While the country remains a popular destination for Muslim tourists from around West Asia and in particular from the Arabian Gulf, the security situation will have to improve if Turkey is to return to its tourists numbers of a decade ago. Now that Erdogan has been granted far-reaching powers, observers will pay close attention to how the president will handle security and increase tourism.
Politics will determine Turkey’s economic future, at least in the short term. The fundamental strengths of Turkey’s economy have not changed much over the last decade. The country is ideally placed between East and West, has phenomenal potential in the construction and manufacturing sectors, and remains an attractive destination for tourists. The past five years have demonstrated that Turkey was over-reliant on foreign investment and failed to encourage sufficient levels of domestic savings to weather an economic crisis. Perhaps most importantly, the country is a lasting example of the need for political stability in the creation of a flourishing economy.
While the immediate negative pressures on the Turkish economy, namely the security situation and political turmoil, do not appear to be easing, the country’s leadership can alleviate some stress on the economy by redefining clear separation of powers in the government. The central bank has the power to reverse some negative trends. The question is whether the ruling party and the president will grant it the authority to do so, now that their power is assured for the foreseeable future.