Despite political uncertainty with the coming elections and setbacks in negotiations with the European Union, Turkey’s economic fundamentals remain strong. While there have been short-term wobbles due to recent events, and long-term issues such as inflation, the current account deficit (CAD) and poverty remain, the IMF and the market expect growth to continue, most likely under the current ruling party with a renewed mandate after July’s elections.
At the end of April, the Turkish stock market and the lira were hit by a statement by the military voicing support for secularism, which was seen as an attack on the ruling Justice and Development Party (AKP) government, with its roots in political Islam. The markets were also influenced by large demonstrations against AKP in Istanbul, Ankara and Izmir.
The demonstrations came in the wake of Prime Minster Recep Tayyip Erdogan’s decision to name Foreign Minister Abdullah Gül as candidate for president, a role elected by parliament. There had already been demonstrations against Erdogan when it was thought that he would stand for the presidency. The opposition boycotted the vote in parliament, so Gül failed to achieve the required two-thirds majority. The vote was annulled by the constitutional court, with the consequence that the AKP announced changes to the constitution allowing the president to be elected directly. These changes have been rejected by the court and secular President Ahmet Necdet Sezer, and will now be put to the electorate by referendum. Meanwhile, the legislative elections have been brought forward to July 22. Tensions are running high between the AKP and Turkey’s secularists, who accuse the party of trying to usher in elective dictatorship as a first step towards Islamic rule.
However, despite the shocks to stocks and currency, the response of the market as a whole appears to be “so what?” Turkey has in the past been vulnerable to capital flight, but business confidence in the country remains relatively unperturbed by political events for two main reasons. Firstly, the economy has been performing strongly enough, with sound enough fundamentals, for the political worries to have less effect than previously. Secondly, the AKP, which has presided over several years of growth, looks increasingly likely to be re-elected thanks to divisions in the secularist camp.
Difficult relations with the EU
Turkey’s strong and stable economic performance under the AKP administration has seen the party win friends in the domestic, business community, the EU and the IMF. The party came to power in 2003 with a majority in parliament, the first since the Motherland Party (ANAP) governments of the 1980s.
Under the AKP, economic reforms have continued, the economy has performed well and a historic milestone was reached when EU accession negotiations were opened. However, as elections drew closer, the privatization program has slowed, and the EU has suspended eight “chapters” (or policy areas) of negotiations due to Turkey’s intransigence on certain issues, including allowing ships and aircraft from the Republic of Cyprus to use its ports and airports.
However, the country’s economy is still in good shape. The budget deficit is 2% of GDP, considerably less than the maximum of 2% required by the EU; public debt, at 61%, is only a touch above the EU ceiling of 60%; and growth has averaged almost 8% over the past four years, taking the average per capita income at purchasing power parity (PPP) to $8,400 in 2006, from $6,700 in 2002, according to the Washington Institute for Near East Policy.
The growth has been boosted by high inflows of foreign direct investment (FDI), which has also been financing the current account deficit. Between 1980 (the year of the last military coup) and 2003, Turkey attracted $18 billion in FDI. However, in 2003, the country brought in $1.7 billion in FDI, and in 2006 $20 billion, a figure that could rise to $30 billion this year.
Turkey’s custom union with the EU has further contributed to country’s economic development. Turkey is one of only two non-member countries with such an agreement. Ulrike Hauer, the undersecretary of the EU Delegation of the European Commission to Turkey said that the EU and Turkey were enjoying good levels of trade and that this has helped Ankara decrease its trade deficit with the bloc. “Turkey’s trade deficit declined to 20% from 60% during its trade with the EU,” she declared.
Economic challenges remain. Inflows of money due to the appreciating lira and high interest rates are restraining corporate profits and exports. The current account deficit remains large and is growing, hitting 8% of GDP earlier this year. Inflation, for years the bugbear of the economy, is under control and decreasing, but still well off target at 9.6% in 2006, with the Economist Intelligence Unit forecasting a 6.5% rate by year end. Official unemployment stands at 9.9%, and poverty remains an issue.
Relations with the EU have been given a further setback by the election of Nicholas Sarkozy as French President, and the subsequent victory of the party backing him in parliamentary elections. Sarkozy’s election platform explicitly stated his opposition to Turkey’s membership of the EU as the country is in “Asia Minor.” A Turkish military incursion into northern Iraq (seen by many as a pawn in the AKP-military game) would also hit relations with both the EU and the US, though it is likely to be a brief operation. Business has been ambivalent about the potential for military action, divided between those benefiting from trade with northern Iraq and those supporting a stronger security focus following the Ankara bombing in late May.
Despite these important caveats, Turkey’s disciplined macroeconomic policies, strengthened economic institutions and structural results continue to bolster confidence. This is apparent from the latest IMF report on the nation’s economic outlook, part of the 2007 Article IV Consultation meetings.
“Turkey’s macroeconomic performance in recent years has been impressive, combining strong growth with a sustained reduction of inflation,” the IMF said in a statement. “Political stability, structural reforms and favorable external conditions have facilitated this good performance.”
According to the IMF, the primary drivers behind growth are private consumption and investment, declining real interest rates, surging capital inflows, rapid credit expansion and rising productivity, combined with falling inflation.
The statement concluded: “The goal should be to build on the economic success of the last five years to firmly entrench high growth, secure low inflation and make the economy more flexible and resilient to external shocks.”
The EIU, sharing the IMF’s confidence, forecasts continued growth, with 5.5% in 2008, 5.2% in 2009, 5.1% in 2010 and 5.2% in 2011.
A June report by ING, the Dutch banking group, pronounced the June EU summit as “a non-event for Turkey,” and said that a likely AKP victory would keep the economy on track, whereas its rivals may herald a return to instability. The report, part of ING’s Prophet series, says that, despite the election of Sarkozy, France is likely to hold off from lobbying to change the objectives of Turkey’s EU membership talks until December.
The report said that opinion polls showing 35-40% support for AKP indicates it is likely to win, “with positive implications for economic development… [and] good news for bonds.” The opposition secular Republican People’s Party (CHP), which is nominally social-democratic, is currently polling around 20%. ING says that the party program, which promises cuts in tax on income and fuel, higher subsidies for agriculture and industry and cheap student loans, “would be very worrying for the market if enacted … it harks back to the populist type policies that voters backed in the 1990s which led Turkey into three economic crises.” However, the report states that the stronger economic foundations existing now could prevent another crisis on the same scale.
The confidence of international institutions in Turkey remains resilient, considerably more so than in the past, despite political fireworks and a worsening in relations with the EU. Turkey seems likely to overcome these headaches and move forward, under an AKP government, albeit perhaps one with slightly clipped wings. However, with Turkish politics known for its volatility, the final outcome of the July elections is still a difficult call.
