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Analysis: Economy becomes liability for Turkey's scandal-hit government

Reuters, Saturday 4 Jan 2014
Views: 2318
Views: 2318

When a senior Turkish businessman publicly criticized the central bank this week for failing to stabilize the tumbling lira currency, he was taking aim at a pillar of support for the government: its reputation for strong economic management.

Monetary policy "is causing losses to companies which made transactions trusting in the central bank", complained Mehmet Buyukeksi, head of the Turkish Exporters Assembly, an umbrella group for about 52,000 companies.

Appointed with the approval of Prime Minister Tayyip Erdogan, central bank governor Erdem Basci has pursued a low-interest policy closely associated with the ruling AK Party's drive to build Turkey up as an industrial power.

So Buyukeksi's criticism was ominous - a sign that Turks, whose real incomes have risen almost 50 percent under 11 years of AK Party government, may be starting to lose faith in the way it runs the economy.

The lira's slide to record lows is saddling companies with higher payments on foreign loans that they took out during the good years. A construction boom, which the government fostered to stimulate economic growth, now looks less impressive after a corruption scandal erupted last month involving state projects.

The scandal, which has led to the resignations of three ministers whose sons were among dozens of people detained, makes it harder for the government to claim global trends, not its own officials, are causing Turkey's economic problems.

More than its Islamist ideology, the AK Party has relied on its economic record to keep the support of many Turks. The sudden worsening of the economy is therefore pushing Turkey into its greatest period of political instability in a decade - just before local and national elections due in 2014 and 2015.

"In Turkey's political environment, a strong economic performance is essential to ensure the acceptance of the government," said Emre Erdogan, founder of Istanbul's Infakto Research Workshop, which studies public opinion.

"As it becomes more difficult for the government to demonstrate this, things start to get more unstable and unpredictable," said Erdogan, who is unrelated to the premier.


A collapse of real investment in the Turkish economy - of the kind which hit nearby Arab economies after their political upheavals in 2011 - does not appear to be on the cards.

Even as the lira slid 17 percent against the U.S. dollar last year, interest in Turkish companies stayed strong; mergers and acquisitions with Turkish targets totaled $15.7 billion in 2013, down 9 percent from its high level in 2012 but up 66 percent from 2011, Thomson Reuters data shows.

The central bank's net foreign exchange reserves of roughly $40 billion are dwarfed by Turkey's external financing needs this year, which Barclays estimates at $217 billion: $164 billion in maturing debt plus a $53 billion trade and services gap.

But the external financing can be managed, at a price, as long as Turkish borrowers retain access to international capital markets. So far they have shown no sign of losing it.

Turkish banks, which account for almost two-thirds of this year's maturing foreign debt, have continued to announce plans for big foreign currency bond issues since the corruption scandal broke; last week Akbank set up a $3 billion global medium-term note program.

"I would make a big distinction between the political and financial situation of the country and I am not panicking about the financial situation," said Benoit Anne, head of emerging markets strategy at Societe Generale.

The lira has been weak partly because investors have been buying currency contracts to hedge their exchange rate exposure, Anne said - not because of a mass pull-out of longer-term capital from Turkey.

William Jackson, emerging markets economist at Capital Economics in London, said foreign debt might cause problems for individual Turkish firms but he did not expect any systemic crisis. He noted that corporate Turkey had coped with lira depreciation in 2008 that was even steeper than in 2013.

"Instead there will be a cycle of gradual pressure on the economy this year - higher debt payments abroad will mean companies cut investment, this hurts employment which reduces consumption and so on," he said.


The lira's slide may be felt soonest in a surge of inflation. The annual rate was 7.4 percent in December; a rise this month in taxes on cars, alcohol, tobacco and mobile phones is expected to boost it by 1 percentage point or more.

"Then we are going to see a large impact on inflation in the next few months due to the exchange rate," as the weak lira raises import costs, said Emre Deliveli, a local economist who has worked at international institutions such as the World Bank.

Although the weakness of the economy will restrain inflation, the rate may rise to 9 or 10 percent - and conceivably higher if the lira continues dropping, he said. A rate of 10 percent or more could have a political impact by worrying businessmen and consumers.

If the corruption scandal spreads, this could start to hurt the real economy. Construction was a major driver of growth as other sectors faltered last year - construction industry turnover jumped 16.4 percent from a year earlier in the third quarter - and it could slow if skittish officials and executives hold off on projects because of legal dangers.

Deliveli and other economists said recession looked unlikely this year but a slowdown in growth to just 2 or 3 percent was quite possible, from an officially estimated 3.6 percent in 2013.

In a country that became used to growth rates of 5 percent or more over the past decade, that would feel like a recession to many Turks. Analysts estimate annual growth of 3 percent is needed just to prevent the unemployment rate, now at about 10 percent, from rising in a young and growing population.

"A rise of 2 to 3 percentage points in the unemployment rate, if it happens, could start to have a political impact," Deliveli said.

These threats to the AK Party's economic record may explain the vehemence of a New Year's Day speech by Erdogan, who told Turks that foreign-backed elements, which he did not name, were trying to steal "the bread on your table, the money in your pocket, the sweat on your brow".

The AK Party came to power in 2002 after unstable coalition governments from the 1990s until 2001 ran into repeated balance of payments problems and economic crises.

"Under the AK Party, people felt that having a strong, united government meant crises could no longer happen," said Emre Erdogan, the researcher. "So the economic problems now are worrying people."

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