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How long can Turkey continue to defy economic gravity?

How long can Turkey continue to defy economic gravity?

When Istanbul’s sparkling new $12 billion (£9 billion) airport initially opens for business in little under 100 days’ time, it will mark the first stage of its plan to be the largest airport in the world and a crown jewel in Turkey’s $200 billion megaproject building spree.

Such a construction drive has fuelled the country's economic boom over the past two decades, according to citizens and investors alike, while president Recep Tayyip Erdogan paints an exciting picture for Turkey’s future, with more dazzling developments in the pipeline.

From an economic point of view, it is clear why Turkey has been a cornerstone for emerging markets investors. GDP grew by 7.4% in 2017, the fastest of any of the G20 nation and markedly up from a sluggish 3.2% the previous year.

Data from the Institute of International Finance last month forecast, that Turkey will attract the highest net capital inflows of any emerging market country this year, at $51.3 billion.

Voicing concerns

But beneath the surface, investors are increasingly voicing concerns over an economy that is overheating, a currency plunging in value, a level of US dollar debt which has soared to alarming heights and inflation spiralling out of control.

It is a situation that has led GAM emerging market bond manager Paul McNamara to call Turkey ‘by some way the worst risk in emerging markets – and that’s including Argentina’. GAM has not held Turkish bonds for well over a year.

He says the country has done ‘the classic emerging markets thing’, having borrowed ‘huge’ amounts of foreign debt to fuel its spending spree, while failing to tackle its current account deficit – which stands at close to 6% of GDP – and ‘burning through its foreign exchange reserves’.

McNamara says: ‘What we’re looking for when assessing a country is a pattern of various risks, and Turkey has been flashing red on all of them. Loads of foreign debt? Tick. Huge current account deficit? Tick. Property boom, politics? Tick, tick. It’s been a recipe for trouble.’

Part of Turkey’s foreign debt problem, he adds, is the ruling Justice and Development party’s (AKP) links to construction. In 2013 the BBC described Turkish construction conglomerate Kalyon Group as a company ‘which has close ties with the governing Justice and Development party.’

McNamara says: ‘The AKP are quite tightly tied-in with the construction industry, which has overseen a lot of prosperity over the last few decades, but that has been fuelled by a huge amount of foreign debt, and that’s a worry considering construction accounts for 10% of the Turkish economy.’

Construction contributed 0.7% to last year’s 7.4% growth figure, but concerns are mounting in the sector over payment problems, a slowdown in new projects and an increase in costs due to the weakening lira. The currency has been hitting record lows against the dollar in recent months.

Self-inflicted problems

Jan Dehn, head of research at Ashmore, is not a fan of Turkey either, and believes Erdogan will struggle to reverse the ‘entirely self-inflicted macroeconomic problem’ he has created.

Erdogan was sworn in as president last week following an election in June. That followed a referendum last year granting the president sweeping new constitutional powers.

The president has declared a war on economic orthodoxy, promising that he will tackle inflation via lower interest rates, and replaced the respected, hawkish former finance minister with his son-in-law and former energy minister Berat Albayrak.

Dehn believes Turkey could be in for a ‘serious macroeconomic crisis’, with inflation surging to 15.4% in June from 12.4% previously, well above a forecast of 13.9%.

He adds: ‘We think Erdogan will struggle to get a grip on the economy, which he manages with the mindset of a mayor (Erdogan used to be mayor of Istanbul).

‘Mayors are good at implementing big construction projects, but less convincing at foreign policy matters and dealing with macroeconomic issues.’

Calm on the surface

While the numbers suggest big problems for Turkey, on the surface at least everything still appears to be okay. Turkish banks remain positive on the economy, despite three downgrades this year from rating agencies Moody’s, S&P and Fitch.

But do not let the banks fool you, says Emre Akcakmak, a portfolio adviser at East Capital.

‘All-in-all, in the underlying economy, things are pretty much the same at the moment. If you speak to any of the banks, they will tell you it’s business as usual,’ he says. ‘But there’s a disconnect between what the banks are saying and what market participants are saying.

‘The outlook is getting materially different on the ground and in six-to-nine months’ time we will see the impact of a higher inflation and interest rate environment, and the lira at an all-time low, on the underlying economy.’  

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