Mustafa Sönmez

The automotive industry has been a major leg in the economic growth model of Turkey’s ruling Justice and Development Party (AKP), which has relied heavily on foreign funds, while encouraging production focused on the domestic market and consumption. Now that this growth model is stumbling, the automotive sector has begun to struggle as well, with production on the decline, coupled with setbacks in foreign trade.

Linked to myriad sectors in the production chain, the automotive industry affects the development of other industries, mainly iron and steel, electronics, software, rubber and plastics, fuel, energy, textiles and chemicals. It is directly linked also to many sub-branches of the services sector such as distributorship, retail sales, insurance, car rental and maintenance and repair. Hence, when the automotive industry picks up, it has an invigorating effect on related sectors, and, conversely, when the automotive industry sputters, it threatens to slow down other segments of the economy.

In 2018, Turkey was the world’s 14th largest producer of motor vehicles. Its output of 1.5 million vehicles, including roughly 1 million cars and 500,000 commercial vehicles, accounted for about 1.5% of the global production of 95 million vehicles. China was the leader with 30%, or 28 million motor vehicles, manufactured last year. The United States was second, yet with less than half of China’s production figure.

In 2012, Oyak Renault dominated automotive production in Turkey, boasting a 54% share. By 2017, it saw its share shrink to 32% as competitors such as Hyundai Assan, Toyota and Tofas stepped up their investments in the country. Toyota’s average share of 15% rose to 24% at the end of 2017 after the company launched a plant in the northwestern province of Sakarya to produce its popular CH-R model for the global market.ALSO READTURKEY ELECTIONSJailed militant leader enters Istanbul election fray

In terms of commercial vehicles, Koc Holding is Turkey’s dominant manufacturer. Its subsidiaries Ford Otosan and Tofas hold market shares of 57% and 35% respectively.

Seven global brands — Volkswagen, Renault, Ford, Fiat, Opel, Toyota and Hyundai — hold a combined share of 63% in Turkey’s automotive market. Volkswagen is the leader, with a 13% market share, followed by Renault with 12% and Ford and Fiat with just below 12% each.

For Turkey, foreign exchange rates constitute a major factor affecting automotive production and importation. The stability of exchange rates contributes to a steady growth of both production and demand for imported vehicles. Conversely, as has been the case in recent years, turbulence in foreign capital inflows and rising exchange rates cause volatility in the sector.

The AKP has encouraged road transport and automotive industry growth through various infrastructure investments, production incentives and loans. As a result, the number of automobiles in use rose to 12.5 million in 2018 from 6 million in 2006, increasing by about 6% on average per year. However, the automotive industry’s growth trend now appears to have stalled.

Despite government efforts to stabilize matters through tax interventions, the sector appears exhausted in terms of production and importation amid ups and downs since 2014. According to the most recent data, covering the first five months of the year, sales declined by 50% from the same period in 2018. Some 152,500 cars and light commercial vehicles were sold from January to May, down from about 302,300 in the same period last year. Reflecting the impact of the economic crisis gripping the country, sales of light commercial vehicles saw a sharper drop of 62.1%, totaling 5,890 vehicles.

The Automotive Distributors Association has revised its market forecast for the year-end to 400,000 sales at best, down from 450,000 sales in its original estimation. The sales of the automotive sector had totaled about 642,000 in 2018, including heavy commercial vehicles.

A similar downtick is observed in exports. According to figures from the Uludag Exporters Union in the northwestern city of Bursa, a major automotive hub, the sector’s exports stood at $11.7 billion in the first five months, falling 7% from the same period last year under the impact of shrinking demand in the European Union.

The weakest aspect of Turkey’s automotive industry stems from its unabating reliance on imports. Low foreign exchange rates until several years ago had increased the appeal of imported inputs, deepening the sector’s dependence on foreign sources. But once the Turkish lira tumbled and hard currency became more expensive, this resulted in sharp cost increases, leading to inevitable price hikes, curbing domestic demand.

In another important downside, local industries lag behind in the design of engine and powertrain technologies, relying again on foreign sources.

Last but not least, the domestic automotive market is saddled with hefty taxes. In addition to indirect taxes, comprising the special consumption and value-added taxes, the government collects a yearly motor vehicles tax from consumers. The value-added tax is fixed at 18%, while the special consumption tax varies from 45% to 160%, depending on engine volumes and pretax prices. The motor vehicles tax, meanwhile, is calculated on the basis of the vehicle’s age, emission rate and number of seats. Apart from the hefty tax burden, the frequent changes in tax regulations represent an additional drawback, creating uncertainty.

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Turkey’s ruling Justice and Development Party (AKP) may have secured a rerun of Istanbul’s mayoral race to try to reverse its defeat in March, but it has had little to celebrate ahead of the critical vote, with economic woes sinking consumer confidence to record lows.

The AKP’s election scores over the years show that the party has suffered setbacks in times of plunging consumer confidence. Turkey today is in the midst of a serious economic downturn that is hitting hard, especially in Istanbul, the country’s biggest city and economic hub.

In the March 31 local polls, the bloc led by the main opposition Republican People’s Party (CHP) emerged victorious, not only in Istanbul, but in almost all major urban centers, including the capital Ankara and the third largest city, Izmir. The AKP refused to concede defeat in Istanbul, the long-standing pillar of its patronage networks, claiming irregularities and raining objections to the higher election board. Under pressure from President Recep Tayyip Erdogan himself, the majority of the judges on the board voted to void the result on grounds that some polling station officials were not public servants, without any mention of vote-rigging. It was an unprecedented move that many saw as a travesty of electoral laws.

The redo vote on June 23 will be Turkey’s third election within a year. In June 2018, the country held parliamentary and presidential polls, which the government brought forward from November 2019, alarmed that the brewing economic crisis would cause it greater political damage down the road. This proved a wise decision, as the crisis was not yet palpable in earnest, and the AKP won the elections.

The crisis quickly worsened, however, leading to a severe currency shock in August under the impact of political spats with the United States. The government scrambled to contain the crisis, but did little to tighten the belt as the looming March 31 polls led it to resort to populist measures. It did manage to reduce the fever of the crisis, but at the expense of braving bigger tremors down the road.

The ire of urban voters hit by soaring prices and growing joblessness was a major factor swaying the local polls, which saw the CHP triumph in 21 provinces that contribute 62% of Turkey’s gross domestic product (GDP). The biggest trophy was Istanbul, which alone accounts for 31% of the GDP. The cancellation of the Istanbul vote has now added a sense of injustice to the public’s economic frustrations.

The protracted election hubbub has left the economy waiting for remedies while continuing to lose blood. The government has kept deferring the drastic measures the crisis requires, sticking to populist policies that only enlarge the Treasury’s gaps.

Amid lingering pessimism over the country’s economic prospects, domestic and foreign actors have increasingly fled the Turkish lira, turning to hard currency. In response, the central bank has scrambled to prop up the lira, draining its reserves, along with other extraordinary steps to back the Treasury in keeping the economy from the edge.

Yet nothing seems to have eased the confidence erosion among the populace and economic actors, as evidenced by an ongoing decline in confidence indices.

The consumer confidence index — compiled through monthly surveys to measure consumer assessments and expectations on their financial standing and the economy in general as well as their spending and saving tendencies — plunged to 55.3 in May. The more the index goes below the 100-mark, the more pessimism it indicates. The May figure was 13% down from the previous month, reflecting a grave erosion of confidence. It marks the lowest level the index has hit in the 17-year history of the confidence surveys, falling 0.4 points below the hitherto dip of 55.7, measured in November 2008 amid the global financial crisis.

The May result speaks of unprecedented gloom among consumers. Pessimism is at its worst level in sub-categories such as expectations on the family’s financial situation, the general state of the economy, a possible improvement in the unemployment rate and saving prospects.

Entrepreneurs remain similarly pessimistic. Those in the retail sector express worries about the future in terms of business volumes, sales and destocking. The survey shows that gloom continues to grip also the construction sector, which used to be the driving force of the economy before becoming the first and most battered victim of the crisis.

The real sector confidence index, compiled from the manufacturing industry, was also down from the previous month. Based on a survey with 1,720 manufacturers, the index dropped 6.6 points to hit 98.9 in May.

Finally, the economic confidence index — the composite of consumer and producer assessments, expectations and tendencies — fell to 77.5 in May from 84.7 in April, dragged down by the tumbling indices of consumers and the manufacturing, services, retail and construction sectors. The last time the index slumped to similar lows was during the 2008-2009 global crisis.

The staggering drops in the economic confidence index and its most important component, the consumer confidence index, are not without political messages, of course. The consumer index also reflects “voter confidence” to some extent. Its ups and downs have always hinged on election results.

In the 2007 general elections, for instance, the index was above 80 and the AKP got nearly 47% of the vote. In the 2009 local elections, the index was down at about 61 and the AKP’s vote dropped to 38%. When the index climbed back to 83 in 2011, the AKP had another big victory with nearly 50% of the vote. By the June 2015 general elections, the index dropped to 65, while the AKP lost its parliamentary majority, ending up with 41% of the vote.

At the time of the March 31 local polls, the consumer confidence index stood at 59. Now, just weeks before the election rerun in Istanbul, it has shed another four points. For sure, the drop is not a literal reflection of voter sentiments, but it is still a major indicator that cannot be ignored.

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The two main actors in the economic crisis gripping Turkey are the central bank, which runs the state’s monetary policies, and the Treasury, which is in charge of fiscal policies. The central bank is ostensibly independent, while the Treasury is attached to Treasury and Finance Minister Berat Albayrak, who is also President Recep Tayyip Erdogan’s son-in-law.

Those who follow how things work on the ground are well aware that the central bank does not act independently and is subject to direct and indirect government meddling. The bank has long felt compelled to seek Erdogan’s blessing in its interest rate decisions. Recently, it has come under pressure to let the Treasury use its resources and — again, at Albayrak’s behest — do something it should never do, namely directly or indirectly intervene in the foreign exchange market. The bank’s role in foreign currency sales by Treasury-controlled public banks, aimed at curbing the slump of the Turkish lira, is a case in point.

The central bank’s transfer of funds to the Treasury is even more intriguing. Such transfers are not something new — in fact, they are required by law, given that the bank is ultimately a state-owned company that transfers part of its profits to the Treasury. This year, however, the transfer that was due in April was brought forward to January via a legal amendment ahead of the March 31 local polls. As a result, the Treasury — saddled with major deficits due to the government’s preelection populism — was able to get early some 34 billion liras ($5.6 billion) instead of borrowing on high interest rates.

The Treasury has now reportedly set an eye on the central bank’s legal reserves, which represent 20% of its profits and a sum the bank sets aside by law to use in extraordinary circumstances. There are legal obstructions to the move, but given the government’s record on respect for the law, many are convinced it would not be discouraged by legal hurdles. Its only reservation seems to be that such a blood transfusion would lay bare the Treasury’s desperate situation for all to see, including the foreign money markets.

In fact, the Treasury’s gaping deficits and growing borrowing needs are already hard to conceal, no matter how much the figures are glossed over.

In the first four months of the year, budget expenditures were up 29% from the same period last year, according to Treasury and Finance Ministry figures. The increase exceeds the consumer inflation rate by 10 percentage points. In the sub-rubrics, the 51% increase in interest spending is particularly striking.

Budget revenues, comprised of tax and nontax revenues, were up only 19% in the same period. In other words, the increase in revenues was 10 percentage points less than the increase in spending and just kept up with inflation.

The contracting economy has also led to a decrease in revenues from indirect taxes levied on many consumption items. In the first four months, tax revenues grew only 6% in what was actually a significant decline in real terms, given the 19% inflation rate.

In stark contrast, nontax revenues increased 78% to 73 billion liras, making for more than a fourth of state revenues. The sum represents one-off revenues, including the nearly 34 billion liras in central bank profits transferred to the Treasury and money generated from paid exemptions from military service and an amnesty for illegal construction.

The extent to which tax revenues cover noninterest expenditures is an important fiscal indicator. In the first four months of the year, the coverage rate was 70%, down from 83.1% in the same period in 2018. Institutions such as the International Monetary Fund (IMF) are very mindful of that rate, and its decrease alone shows how debilitated the Treasury has become.

To tackle such budget woes, one looks either for a way to increase taxes or, as is more often the case, for new sources of nontax revenues, coupled with borrowing. For Turkey, the potential of nontax revenues is more or less exhausted, with almost no public assets left to privatizeor sell off. This leaves borrowing as the sole option. Because of rising interest rates, fresh borrowing means increased interest expenditures in the budget. And when the government takes to the stage as a borrower, interest rates rise further. Growing interest expenditures eat into public spending in realms that bear upon lower and middle classes such as education, health care, social welfare and agricultural supports. As such, they come with serious political costs.

Budget deficits and a hefty public debt were the main problems in the severe economic crisis that Turkey experienced in 2001. According to IMF data, the budget deficit reached 12% of gross domestic product (GDP) that year, while public debt amounted to more than 76% of GDP. As a result of measures enacted under a standby deal with the IMF in 2001 and 2002 by the then-coalition government and, from 2003 onward, by the Justice and Development Party (AKP) — mostly the privatization of public entities — Turkey’s public deficit decreased to less than 1% of GDP by 2006, while public debt fell to 27% of GDP. Budget discipline became the key item in the AKP’s showcase as it sought to secure funds from foreign sources.

The economic woes since 2016, however, have led the AKP to use mostly the Treasury in managing the economy, including increased spending and tax exemptions in a series of election seasons. As a result, the budget deficit began to enlarge anew, reaching 3.6% of GDP in 2018. Public debt, meanwhile, is currently approaching 30% of GDP.

Fears are rife that budget gaps and public debt will continue to grow. The government going out to the market as a borrower could further upset the already fragile balances. Hence, Ankara’s quest for one-off revenues never ends. Now, it has gone as far as to consider a legal amendment to transfer the central bank’s legal reserves — a sum of about 40 billion liras ($6.6 billion) — to the Treasury.

Such a blood transfusion would not only deal an ultimate blow to the central bank’s claim at independence, but will also raise a huge risk of leaving the bank without a sail in some storm down the road. The intent for such a one-off funding operation, which lacks clarity on how much debt it could manage and for how long, is hardly flattering for the Treasury’s image. For Turkey’s foreign lenders, in particular, it is a reflection of how weak and vulnerable the Treasury has become. Still, the government is unlikely to give up on that money.

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ARTICLE SUMMARYThe cancellation of the opposition victory in the mayoral race in Istanbul has raised the specter of more trouble for the Turkish economy, which is already grappling with recession and currency-related tumult. REUTERS/Murad SezerA mayoral election banner with the pictures of Turkish President Tayyip Erdogan and Justice and Development Party candidate Binali Yildirim is seen over the Galata Bridge, Istanbul, May 7, 2019.

A fresh bout of turbulence hit the ailing Turkish economy May 6, when the Higher Election Board quashed the opposition victory in the March 31 mayoral race in Istanbul, fueling fears that Turkey’s rulers are no longer committed to ceding power through elections. The turbulence is likely to continue until, and perhaps beyond, the election rerun, scheduled for June 23.

A series of elections in recent years have increased the fragility of Turkey’s faltering economy, which badly needs structural reform. The presidential and parliamentary balloting in June 2018 and the local elections on March 31, however, have led Ankara to pursue populist measures instead of focusing on reform.

Many had hoped that the aftermath of the local elections would bring a transition to an overhaul program, including a tightening of monetary and fiscal policies. Instead, the ruling Justice and Development Party (AKP) and its Nationalist Movement Party allies objected to the Istanbul victory of Ekrem Imamoglu of the main opposition Republican People’s Party (CHP), leading to 35 days of wait-and-see for the economy. Eventually, under pressure from President Recep Tayyip Erdogan, the election board made the unprecedented decision of voiding the result — a move that many consider a “massacre of law” — and scheduled another vote for June 23, setting the stage for full-fledged turbulence.

The Turkish lira nosedived as soon as the decision was announced. It has continued to lose value ever since, despite interventions to curb its fall. The lira, which traded for less than 6 per dollar ahead of the decision, hit 6.24 against the greenback at noon on May 9, its weakest level in eight months.

Market actors believe that Ankara pushed public banks to sell foreign currency to save the lira from an even more dramatic slump. According to traders speaking to Bloomberg, state-run lenders sold more than $400 million of foreign currency after the lira breached the 6-per-dollar mark on May 6. The sum was later said to have reached $1 billion.

Yet, this effort to control exchange rates via public banks is hardly sustainable, especially at a time when the decline in central bank reserves is making headlines in the international media. To control exchange rates, the central bank has to hike interest rates on the lira, or the rates will spiral out of control and go through the ceiling. The bank, however, remains under harsh pressure against hiking rates, as Erdogan and the domestic market-reliant business groups behind him strongly oppose such moves.

The lira’s slump, however, is not solely fueled by domestic political jitters and electoral uncertainty. There are also headwinds from the global political climate.

Tensions between Ankara and Washington are running high over the looming delivery of Russian S-400 air defense systems to Turkey amid increased contacts to avert a crisis. As a reminder, it was political spats with Washington, resulting in US sanctions on Ankara last summer, that fueled the currency crisis in Turkey. The economic contraction triggered by the currency shock is still ongoing.

There is also the additional factor of Washington fanning global jitters. On May 5, President Donald Trump threatened to raise tariffs on Chinese goods, reigniting global concerns over the trade war between the world’s two biggest economies. According to some estimates, a new escalation in the war would hit both sides, with China losing $1.2 trillion, or 1 percentage point of its gross domestic product (GDP), and the United States losing $870 billion, or 0.45 percentage points of its own GDP.

The impact of such global woes is usually bigger on emerging economies such as Turkey because when the global economy contracts, it also shrinks the room for emerging economies to export their goods, secure external borrowing and roll over their debts.

US sanctions designed to curb Iran’s oil sales are also negatively affecting Turkey, Iran’s western neighbor. Turkey is now supposed to go looking for alternative oil suppliers with higher prices. This, in turn, threatens to widen Turkey’s current account deficit and raise the cost and prices of energy at home.

In sum, the AKP government faces an adverse global climate as it struggles to manage politics and the economy at home. The Turkish economy, which contracted 3% in the last quarter of 2018, shrank another 4% in the first quarter of this year, according to an estimate by a research center at Istanbul’s Bahcesehir University. The official figure is scheduled to be released in late May.

Year-on year consumer inflation hit 19.5% in April, with no sign of slowing. Food inflation is even higher, reaching 32% and standing out as a crucial factor swaying voter behavior.

The unemployment rate is even more alarming. The new official rate, scheduled for release May 15, is expected to be a record one, exceeding 15%. The rate currently stands at 14.5%. In terms of numbers, more than 5 million are looking for jobs. A broader definition of unemployment that includes people who have given up on chasing jobs puts the number at 8 million.

The gloomy economic indicators, coupled with uncertainty over the mayoral election in Istanbul, have also stoked Turkey’s risk premium, which is reflected in credit default swaps (CDS) and constitutes the most important indicator for international investors. Since the cancellation of the opposition’s Istanbul victory, the country’s CDSs have surged to more than 480 basis points, severely decoupling from those of its emerging economy peers. This means that external borrowing is becoming all the more difficult for Turkey, with the money paid on interest rates reaching exorbitant levels.

In sum, the cancellation of the mayoral election in Istanbul has plunged Turkey into another highly fragile period. The economic turbulence is expected to exacerbate the daily financial woes of Istanbulites and lead them to respond accordingly when they vote in the June 23 rerun election.

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In times of economic crisis, the cost of recovery is often borne by taxpayers at the end of the day. Turkish taxpayers, who are no stranger to such injustice, are made to shoulder the burden again as Ankara scrambles to contain the economic crisis bruising the country since 2018. To clear the road wrecks the crisis has caused, the government is intervening both directly and indirectly, but, more often than not, its measures enlarge the gaps in public finances, billing the ultimate cost to taxpayers.

Public banks have been used in efforts to curb foreign-exchange prices, selling foreign currency at below-market prices. They have been tasked also with financing projects, including non-feasible ones, acting largely at the behest of President Recep Tayyip Erdogan. Public lenders Ziraat and Halk have provided the loans for Istanbul’s posh new airport after its builders failed to secure funds from foreign creditors. Even the acquisition of Turkey’s largest media group, Dogan, by the pro-government Demiroren group was financed through a Ziraat loan.

Under the worsening impact of the crisis, however, collecting on such loans issued on instructions from above has become increasingly difficult. With their balance sheets crippled by bad loans, public banks — placed in a sovereign wealth fund chaired by the president — have become largely incapable of lending. As a result, they have been provided with fresh capital, first via the Unemployment Fund and, most recently, through an injection of 3.7 billion euros by the Treasury, making them fit for new rescue operations, the first of which aims to salvage the construction sector.

The plan was first brought up April 10 by Treasury and Finance Minister Berat Albayrak as he announced measures to tackle the economic crisis. Albayrak said two separate funds would be set up for the debt-ridden energy and construction sectors “to clear bad assets via debt-shares swap and improve the balance sheets of banks.”

Subsequently, the Capital Markets Board announced April 18 it had approved the creation of a Brand Real Estate Investment Fund by Ziraat Portfoy, a subsidiary of Ziraat Bank. The pro-government daily Sabah reported April 29 that the fund would have a capital of 5 billion Turkish liras ($836.7 million) and take over residential and commercial properties that remain unsold in the hands of companies from the Association of Housing Developers and Investors, which produce brand projects.

Turkey’s housing market, which experienced an unprecedented boom under the Justice and Development Party (AKP), was among the first to plunge into turmoil amid the economic downturn. The housing-dominated construction sector was a main driver of the economy for years, thriving especially in profit-rich Istanbul. This capital accumulation model, which relied on domestic demand and external financing, began to lose steam from 2013 onward before hitting a deadlock after a 15-year heyday. Companies struggled to repay foreign loans as hard-currency prices shot up and the cost of external borrowing increased amid a simultaneous increase in inflation and interest rates on the Turkish lira. Housing demand plummeted, leaving companies with a large amount of unsold stocks.

The apartment stock, for instance, is estimated to have increased by more than 1 million in the past six years alone. The number of occupancy permits issued to new apartments from January 2013 to December 2018 stood at about 4.7 million, which could be read also as the number of apartments offered for sale. In the same period, only 3.6 million new apartments were sold, with the difference indicating the swelling stocks.

Yet not all companies saddled with stocks will benefit from the bailout scheme. The rescue operation via Ziraat will cover mostly the so-called “brand projects” or residential and commercial real estate developed by big companies such as Agaoglu, Sur Yapi, DAP, Sinpas, Kuzu, Nef and Torunlar, which have collaborated with the public housing agency TOKI and its subsidiary Emlak Konut. Construction companies top the list of loan defaulters and many of them are closely linked to the AKP.

The beneficiary companies, organized under the roof of the Association of Housing Developers and Investors, will hand over their stocks to the Ziraat Portfoy’s fund. Appraisement firms approved by the Capital Markets Board will determine the total value of the properties, which include shopping malls, office towers, hospitals and schools along with residential buildings. Following the handover, the loan debts of the companies will be subtracted from their receivables from the fund. Banks, meanwhile, will receive shares from the fund for their loan dues. Thus, debts and shares will be swapped, reducing the bad-loan ratios of banks and clearing the clogs that indebted builders have placed in the way of lending channels. The companies, for their part, will get rid of the pressure of banks, offload their stocks, even if on discounted prices, and fix their balance sheets to become eligible for loans again.

But what about the fund, which will function as a sort of a sponge soaking in the dirty water? How will it sell the assets and provide earnings? Amid the decline in demand, home prices as well as returns from real estate investment partnerships have gone through the floor. According to central bank data, housing prices in Istanbul, for instance, dropped 1.7% in February from the same month in 2018. With inflation factored in, the real decrease is nearly 18%. For Turkey in general, the decline is about 13.3%. With such a sharp drop in the prices, the fund’s prospects are rather bleak.

In the current economic climate, the fund appears destined to go into the red. In other words, it is the public Ziraat Bank that will incur losses. The Treasury might still help it out with capital injection, but ultimately, all those operations are swelling the public debt and raising the cost of rolling it over, bringing closer the prospect that Turkey will have to go to the International Monetary Fund. The government’s mounting interest expenses eat into the budget shares of education and health care, foisting the burden of imprudent policies on taxpayers at the end of the day.

Moreover, there is already speculation that real estate stakes accumulated at the “sponge” fund might be sold well below their value to some sub-funds close to the government. Thus, public losses might also turn into profits for certain cronies down the road.

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