In the face of a global economic slowdown and after undershooting growth and investment targets in 2007, Turkey’s government has reaffirmed its commitment to reform and privatization. The administration of Prime Minister Recep Tayyip Erdogan and his Justice and Development Party (AKP) had been accused of taking its eye off the economic reform ball amidst verbal warfare with the army, two elections and a referendum as well as military losses in a series of clashes with Kurds across the border with Iraq. However, the worsening global outlook and an impressive mandate appear to have reinvigorated the government’s appetite for change, with a raft of reforms including a reduction in social security payments by employers and a possible cutback in expenditure and a restructuring of agricultural subsidies. Economy minister Mehmet Simsek has also announced that a series of privatizations will commence this year. The scope of reforms is still unclear and investors burned by the credit crunch may look at the government assets up for sale with more caution than previously.
Growth in 2007 was below the government’s 5% target, at between 4-4.5%. Simsek has said that this performance is still “impressive” and attributed the lower than expected figure to unavoidable supply side issues such as higher fuel prices and drought, which caused agricultural production to fall by 6% in the first three quarters of 2007.
However, suspicions remain that a cooling in investors’ enthusiasm may also have played its part. Last year foreign direct investment (FDI) came in at $19 billion, well below the forecast $25 billion. Historically, Turkey has been — and still is — vulnerable to capital flight. While losses after the last notable shock, in May 2006, were fairly moderate and were made back quickly, fears remain that Turkey is still somewhat exposed and could suffer as a result of the global credit crunch and the looming possibility of a recession in the United States. Even at $19 billion, FDI is still equal to the amount Turkey brought in for the 23 years between 1980 and 2003.
Lowering the social security burden
On January 10, Erdogan announced the reform program for the coming year, some items in more detail than others. Most interest was generated by the decision that social security payments owed by employers will be cut by 5% to reduce the burden on business and encourage job creation. The bureaucratic burden is cited as a deterrent to expansion by some firms in Turkey. By reducing the payments — essentially a tax on employment — the government hopes to make it more attractive for firms to take on more workers. The cut may well help reduce unemployment but only if growth rates remain steady at best and preferably rise. It is also feasible that firms’ boosted growth and an increase in the number of those paying income taxes will offset the loss of government funds from the cut, so it may have a fiscally neutral or even positive effect. Certainly the government must be hoping so, since social security expenditures eat an increasingly large hole into the budget. In 2006, $19.2 billion was allocated to social security, double the amount allotted to investment.
Pertinently then, the reform package may reduce the payments to citizens. Currently, 90% of the Turkish population directly or indirectly (as, for example, dependents) receives social security money. If Erdogan can grasp this particular nettle, he can make significant progress in his confessed aims of reducing government indebtedness and liberalizing the economy.
It may be that he faces some opposition from the conservative wing of his party and trade unions, which can be skeptical about “liberal” measures that appear to reduce the income of the lowest-paid. They are also worried that the cut may be the first step in “unfairly” skewing the burden of payments onto workers rather than employers.
However, there is a case to be made that many of the social security disbursements go to those who do not need them, and that they would be better focused on the poor. And job creation will benefit the poorest – those currently unemployed. Additionally, Erdogan has an undeniable mandate for change.
The government is already committed to reducing one key outgoing; it is to scrap direct income subsidies to farmers, instead providing financial support on product prices. It also plans to link subsidies to production, rather than land holdings.
The scope of any reduction in social security is still uncertain, and there are doubts that the government will make the cuts it could; market analysts have been lukewarm on announcements made thus far. Details of many points on the reform agenda remain opaque, and a timetable of implementation has yet to be finalized.
Committed to liberalization
But a radical move to cut payments would reaffirm the AKP’s commitment to liberalizing the economy and reducing government debt, sending an effective message to investors and opposition alike.
Erdogan’s government is, however, likely to show some determination on those twin goals of liberalization and cutting debt through stepping up its privatization campaign this year.
Financial institution Halkbank, tobacco firm Tekel and another part of Turk Telekom are likely to be put up for sale this year, and the longer process of privatizing Turkey’s 20 regional electricity distribution firms will commence. The Halkbank sale could draw in around $9 billion, and Tekel and the government’s 15% stake in Turk Telekom are likely to prove attractive to investors as well. The electricity firms were due to be privatized by 2010; while a more likely target now is 2012, at least the momentum to sell them off has been restored. Oger Telecoms of Saudi Arabia, part of the Saudi Oger Group owned by the Hariri family, paid $6.55 billion in 2005 for a majority stake in Turk Telekom.
These new sales should provide an invaluable boost to FDI after a year in which expectations fell short; Simsek hopes to at least match last year’s figure.
However, the worsening global financial situation, which has seen major US banks announce astronomical write-downs and sharp falls in stock markets, particularly in the emerging economies of Asia, does not bode well for the privatizations’ yielding the revenues hoped for. Given Turkey’s history of capital flight, investors may be wary of a sharp slowdown in the economy and a decline in the value of the currency if the global bailout persists much longer. A January report by Aon Trade Credit Global, part of Aon Corp, a US insurance and consultancy firm, named Turkey as one of the countries most vulnerable to the effects of the credit crunch, due in part to its high budget and current account deficits.
Correction looming?
Even if the global economy pulls through, there is a widespread feeling that the lira — currently trading at around 1.18 to the dollar — is overvalued and is due a correction. This would of course be sharpened by a flight to safer assets.
In the event of a recession in Western markets and an investor withdrawal, Turkey is likely to suffer but may find that its growth momentum is sustained to an extent by the continuing investment rush fuelled by Gulf oil money. Companies and funds from these nations, many of them linked to their governments, are increasingly looking to diversify their portfolios and pump liquidity out of their overheating markets. They have been expanding across the Middle East and North Africa, and Turkey is no exception. The largest proportion of the investment thus far has been in real estate, and this is likely to be sustained this year. Meanwhile, the Turk Telekom and Halkbank sales may well attract Gulf firms which are buying up foreign companies with enthusiasm.
