Mustafa Sönmez – Hürriyet Daily News, Nov/9/2015

There is an important economic agenda for the Justice and Development Party (AKP), which came to power again with a quite surprising 49 percent of the vote in the Nov. 1 election. At the center of this agenda is the increase of foreign capital inflow. This requirement is very important both for growth targets and also to be able to rollover the debt burden we are face-to-face with.

From the first months of 2015, it can be seen that foreign capital inflow is visibly lower compared to previous years. As of September, Turkey’s current account deficit for the last 12 months was $43 billion but the capital inflow was $31 billion. The $12 billion difference was met by reserves and foreign currency inflow of uncertain origin. In previous years, there has not been such a need of reserves and other money sources to this extent. The decrease in foreign capital inflow is the highest in portfolio investments.

This decline of capital inflow is largely related to the increase in political, economic and geopolitical risks. Along with these local risks, the rate increase agenda of the U.S. Fed makes the foreign investor mobile, making them adopt a come-and-go stance. However, at the end of the day, the notable decline in foreign capital inflow in 2015 brought an unprecedented hike in the dollar exchange rate. The dollar was above 3 Turkish Liras before October and the annual change reached 36 percent nominally and 27 percent net of inflation. In October, with the effect of a relaxation by the Fed, the dollar/lira exchange rate also relaxed; however, this is temporary and depending on the Fed, a re-exit of foreign capital and following it, a climb in the dollar/lira rate is expected.

The renewed government is aiming to minimize the visible risks to re-enable the foreign capital inflow it absolutely needs. The renewed single-party government is considered the most important attraction. However, economic burdens, especially the foreign debt burden makes Turkey look highly fragile.

Foreign capital for growth

The 3 percent growth which was obtained in 2015 by scratching the bottom of the domestic market is not satisfactory for Turkey. The Medium Term Program (OVP) forecasts 4 percent growth for 2016. Compared to previous years, this is a modest target.

Because of intense capital inflows from 2002 to 2007, the drop in the dollar exchange rate was more than 12 percent annually. In this time, which was also the rise of the AKP, average annual capital inflow reached $25 billion and not only was the $19 billion annual current account deficit paid, reserves strengthened also. A similar climate was experienced in most of the “emerging” countries, from Brazil to India, South Africa and many Asian countries. The abundance of liquidity looking for a place to go, as well as the suitability of domestic dynamics, was influential in capital inflows and high growth.

In the second phase, which was between 2009 and 2015 when the global crisis hit, the dollar exchange rate lost an average of 5 percent annually. The years 2009 and 2015 pushed this average upward. In 2009, the loss against the dollar net of inflation was 19 percent; in 2015, it was 27 percent. In 2009, the dollar exchange rate was 1.55 liras; it went up to 2.85 liras in 2015. This nominal increase when freed from inflation is 5 percent annually. Nevertheless, even though this devaluation concentrated on two years and affected growth negatively, it was nevertheless spread in time. During the 2009-2015 period, the average annual general growth dropped to 3.5 percent, which corresponds to a decline of 3 points compared to the growth of the 2002-2008 period.

The decline in growth to 2 or 3 percent in recent years would not satisfy the population in Turkey, which is going through an official unemployment of 10 percent and, in reality, 17 percent. The required average growth rate per year is minimum 5 percent, but for this the continuity of foreign capital inflow is necessary. This tough issue, re-attracting foreign capital in this changing world climate and under the circumstances of Turkey’s increasing risks, is for the new government to solve.

Debt burden

It is vital for the new government to reactivate foreign capital inflow not only for the financing of growth but also for the rollover of Turkey’s outstanding external debt of $405 billion.

As of the end of June 2015, 71 percent of the outstanding external debt of $405 billion corresponding to $287.5 billion belonged to the private sector, the remaining 29 percent to the public sector.

The debt burden of the private sector increased particularly in those years when the exchange rate had a low course. In 2003, the first year of AKP rule, the private sector’s debt burden was $49 billion, having a share of 34 percent in Turkey’s total of $144 billion that year. Today, in other words 13 years later, the external debt burden of private firms and banks is $287.5 billion, equaling 71 percent of total debts.

More than two-thirds of this debt is short-dated. Those that have a 12-month maturity are 40 percent of the total. In other words, the renewed AKP government has a tough mission to create the means of rolling over a debt of $162 billion in 12 months with the least cost.

External world cautious

With the election results, the decrease in uncertainties and the fall in risks caused the valuation of the lira and the bourse to rise in the first business days after the election. However, the external world is cautious. It is exceptionally normal that markets react so to election results, however it is a reality that the external world has adopted quite a cautious approach regarding the problems Turkey is facing and the developments that might come later.

For instance, international rating agency Moody’s said the election result removed political uncertainty, however, the credit outlook will be determined by the policy environment and policy implementation that would overcome a slowdown in growth and high inflation, as well as the inhospitable capital environment that most (emerging markets) are going to be facing.

The rating agency said banks in Turkey still face elevated risk aversion toward emerging markets and elevated geopolitical risks.

Western analysts who regarded Turkey as a “model country, a miracle country” in the first years of the AKP rule are now saying that because of President Recep Tayyip Erdoğan’s polarized stance, Turkey is now facing the risk of becoming an unmanageable Middle Eastern country. For instance, The Guardian writer Simon Tisdall wrote that Erdoğan was hailed by supporters as the “new [Mustafa Kemal] Atatürk,” mocked by enemies as a “wannabe Ottoman sultan.” Erdoğan now had the chance to shape modern Turkey to his liking and stamp his character, vision and conservative, neo-Islamist views on the country for generations to come, he also wrote.

On the other hand, there is also an anxious wait in the outer world on who will administrate the economy in the new cabinet. It is understood that if names such as Ali Babacan and Mehmet Şimşek are appointed, then these concerns will be removed but in the case that a team close to Erdoğan is selected, then these concerns will grow.

Written by Mustafa Sönmez