As Manchester United’s Cristiano Ronaldo discovered in Moscow in May the twisting path from being a hero to potential super villain and back to hero can be very short. The man who is arguably the world’s best footballer scored a goal, missed a penalty but ended on the winning side at the Champions League final against Chelsea. Durmufl Yilmaz, governor of the Turkish Central Bank (TCMB) and arguably the best macro-manager of the economy the country has, might care to take lessons on how to achieve the same rapid transformation.

The bank and its boss have gained many plaudits for shepherding the monetary measures that slashed inflation rates of three figures to single digit levels. The TCMB at one time even forecast the level would fall to 4% this year, an event as likely as sacked Chelsea manager Avram Grant getting his job back.

Measured by the consumer price index (CPI), inflation hit 9.66% year-on-year in April, in which monthly inflation was 1.68%, according to the Turkish Board of Statistics (TUIK). Electricity price increases in June will not help. Domestic usage is to go up by 14% while the rise for industry is even higher, at 19%.

Inflation, long Turkey’s largest macroeconomic bugbear, has been on the rise again after a significant drop from the 1990s, when it regularly registered 100% or more. In 2005, the rate was brought down to 8.2%, from around 25% the year before, before climbing again to 9.5% in 2006 and 9.8% in 2007.

Inflation was so rampant that the Turkish lira was at times the least valuable currency in the world until six zeros were lopped off the currency in 2005. In 2004, $1 was equal to 1.35 Million lira. Thus controlling inflation has been seen as one of the greatest successes of Turkish macroeconomic policy in recent years, earning praise not only for the central bank but also for the Justice and Development Party (AKP) government.

Whose trophy?

Skeptics of the latter’s rule attribute more credit to the former, as well as to previous governments and the International Monetary Fund (IMF), which imposed a fiscal straightjacket on Ankara in exchange for more than $45 billion of funding since Turkey’s 2001 financial crisis.

Arguably, the AKP has risen conveniently on the world boom in emerging markets, facilitated by policies actually implemented by its predecessors. Nonetheless, given its parliamentary majority — a rare occurrence in Turkey’s notoriously unstable political history — the stability afforded by the AKP’s rule has helped secure investors’ confidence.

Economy Minister Mehmet Simsek has argued that the spike in inflation has largely been caused by external factors on the supply side, particularly rising global food and fuel prices. He asserts that the long-term trend is unequivocally toward deflation. “The risk of a persisting inflation shock in Turkey is very low. Currently, we are faced with the pressure of supply side and cost-based inflation,” he has told the press.

“What we have in Turkey is relative success. If you compare our inflation increase with that of other countries which are targeting lower rates of inflation like us, the difference has become smaller. Inflation in Turkey has gone up relatively less.”

The numbers game can, however, be a little deceptive. Turkey’s inflation rate has been on a gentle upward path even since the first year it came down to single digit level. Even so, fiimflek has a point — the ailing economies of the United States and Western Europe are experiencing a jump in inflation due to the rising cost of oil, food and commodities.

Oil prices recently hit $130 a barrel and counting. The effects of geopolitical instability — near-civil war in Iraq, Iran’s increasing belligerence towards the West, tension over the Palestine issue, unpredictability in Nigeria, declining confidence in the intentions of the CIS and Venezuela’s brand of eccentricity — have contrived with increasing demand-pull from burgeoning economies such as China and India to drive up the price of crude.

Food prices have been driven up by a number of factors. Many emerging markets experienced bad harvests last year. Turkey itself suffered drought, as did Morocco and Syria, among others, while floods slashed Bulgaria’s agricultural output.

More importantly as a long-term trend, increasing consumption of meat in emerging markets has put upward pressure on prices. Land that previously supplied cereal crops has been turned over to livestock, which is a less efficient and more expensive way of generating calories for consumption. Furthermore, the enthusiasm that North America, Europe and parts of Southeast Asia have found for biofuels has led to a shift away from food crops. Few countries have been immune from rising food costs, which have contributed to escalating wage demands and therefore fed through to the wider economy.

Building boom inflation

A third factor is the rising cost of other commodities, particularly building materials. Due partly to a worldwide construction boom, particularly in China, prices of steel and cement have been rising at double-digit annual rates. New buildings to satisfy increased demand for higher-grade property (of all types) are getting more expensive to construct. The commensurate rise in property prices and rents has fed through to increased consumer prices and, again, rising wage demands. So if fiimflek is saying in a long-winded way that it could have been worse, he is right.

One of the three domestic factors helping to push up prices in Turkey is the influx of capital. After a sluggish performance in the 1980s and 1990s, Turkey has of late experienced a flood of foreign direct investment (FDI): $19 billion in 2007, up from $17.6 billion in 2006 and $622 million in 2002, according to the central bank. The rise in oil prices has not only had a demand pull but also a supply shock effect as Gulf investors have pumped their petrodollars into the Turkish economy, particularly in the banking and real estate sectors.

Secondly, the AKP has been accused of upping public spending too much, further fuelling inflation. The government has a mandate to reduce poverty and has a large following among the less well-off, encouraging it to increase wages and public spending. Facing rising resistance from the secular and largely middle-class opposition, the AKP is loosening the purse strings to secure its support with the bulk of the population.

On May 15, in what some have seen as a symptom of increasing fiscal laxity, parliament voted to forego most of the interest payments due on $18.8 billion of late social security payments. The government also cut its primary public sector surplus target from 4.2% of GDP to 3.5%, compared to the 6.5% goal imposed under the tutelage of the IMF, whose mandate to recommend policy in Turkey (the condition of a $10 billion loan) expired May 10.

Finally, the weakening of the lira this year (by around 10%) has added to import costs, although it should be noted that inflation was climbing before the currency took a hit, and some consider it still overvalued.

The central bank appears more concerned with inflation than the government. On that busy May 15, the TCMB increased its overnight borrowing rate 50 basis points to 15.75%, indicating it saw inflation as a greater immediate risk than slowing the economy. The lending rate increased from 19.25% to 19.75%.

Yilmaz expects inflation to remain high the next few months and further increases may be required.

But the rate rise has drawn the ire of some business leaders, who argue that promoting growth should be the bank’s priority. GDP growth dropped to around 4.5% last year after topping 6% in 2006, and the IMF foresees a figure of less than 4% this year.

Ömer Cihad Vardan, Independent Industrialists and Businessmen’s Association (MÜSAD) President and Ankara Chamber of Commerce (ATO) head Sinan Aygün said the rate hike would impair business expansion and employment, while benefiting only currency speculators.

Rumor has it government has been leaning on the TCMB to freeze rates — claims strenuously denied by the AKP. But certainly the relationship appears anything but cordial. Zaman Today Columnist Asim Erdilek said the bank would “probably have to increase its benchmark policy rates by another 100 basis points by the end of the year.” He also recounted the tale of Yilmaz and his senior aides being left to “cool their heels for five hours in the Prime Ministry, in a room without cell phone reception, prior to Yilmaz’ more than hour-long, 107-slide PowerPoint presentation” justifying the rate rise. Some ministers are said to have criticized what they saw as an attempt to blind them with science in a talk that was highly technical. Yilmaz retorted that bankers have their own language. As Erdilek explained, “Perhaps what bothered some of the ministers was Yilmaz telling them the government had to practice fiscal discipline and move forward with structural reforms.”

Clearly there is some disagreement within Turkey about whether slower growth is a price worth paying for keeping the old inflationary beast caged. Given the tense political situation as well, the argument seems unlikely to be settled conclusively at the moment and the government has enough problems without facing a penalty shootout against a supposedly independent central bank.

Not an oil-producing country itself, Jordan has nonetheless benefited from the oil riches in recent years. Along the intertwining roads that crisscross Amman’s calcareous landscape, luxury villas and a rising towers are built. Reflecting the country’s positive economic environment, the Jordanian banking sector continues to display sound financial indicators.

The Jordanian banking sector currently has 23 banks, of which eight are foreign institutions (including two Lebanese), two are Islamic banks and 13 commercial banks, according to Khouloud al-Saqqaf, Vice Governor of the Central Bank of Jordan (CBJ).

A March 2008 IMF report describes the Jordanian banking sector as well capitalized with low non-performing loan ratios, strict loan classification and provisioning rules requiring banks to maintain adequate loan-loss provisions.

The entry of regional players has rendered the market more competitive and prompted the introduction of more sophisticated products. As an indicator, “the number of ATM machines has also been growing significantly,” added the vice governor.

By Q3 of 2007, the Jordanian banking sector grew by $3.89 billion, representing an 8.44 % growth from 2006 year-end to reach $50 billion, according to a report published by Jordinvest, a local financial company.

Players in the banking sector

The Arab Bank was the largest contributor to this increase, its total assets soaring by $2.35 billion. This growth was generated by a surge in net credit facilities estimated at $1.2 billion, accounting for a 10.73 % rise in the first six months of the year. The Housing Bank for Trade and Finance came in second place contributing to an increase of $600 million in total assets, driven essentially by the $266.8 million growth in cash balances at banks.

The Jordanian banking sector is extremely concentrated as demonstrated in the market share of the Arab Bank, which can accounts for just over 60% of the banking sector institutions’ total increase

The entry of the Dubai International Capital into the Jordanian market, through the acquisition of shares in the Industrial Development Bank, will certainly affect the market positively, more particularly in terms of Islamic banking, al-Saqqaf believes.  In Jordan, Islamic banking caters for mostly a clientele base. “High liquidity levels boasted by Islamic banks might redirect their funds towards the Gulf to invest that excess liquidity,” al-Saqqaf explained.

In terms of the allocation of credit facilities by economic activity, al-Saqqaf said that the share of the retail sector was estimated at 28%, general trade at 22%, mining and industry at 18.8% and construction at 17.7%. “Loans to the retail sector are limited, however, by law to about 20% of banks assets,” she pointed out.

Facilities granted for general trade and construction purposes were the largest contributors to the growth experienced by banking sector, displaying a rise of $546.3 million and $440.6 million respectively. The mining sector registered the largest percentage growth at 89.48 %.

The IMF estimates that in order to prevent a further increase in the loan-to-deposit ratio, especially of some of the smaller banks that presently have relatively high ratios, prudential limits on the sources versus uses of funds that are under consideration should help mitigate risks. “In addition, they will likely act to curb credit growth, thereby reducing inflationary pressure Although the share of credit to the construction sector and to purchase stocks has increased in recent years, appropriate prudential regulations are in place to curb banks’ exposure to the real estate sector and the stock market,” the report stated.

One particularity of the retail lending segment is born out of the large projects that are underway in the Hashemite Kingdom. According to the Oxford Business Review, Nour Nahawi, the CEO of Arab Banking Corporation in Jordan, has said that, “The demand is in mega-capitalized banks to cope with potential projects like the Red-Dead Canal. Capital must be sizeable enough to remain in step with economic growth.”

Khouloud al-Saqqaf confirmed that another market segment is showing growth levels as ratio of retail to corporate loans have been rising significantly of late.  “The corporate market, which is extremely competitive, has pushed banks to expand their retail activity,” she said.

Total liabilities increased by $3.55 billion, hitting $42.3 billion, mainly fuelled by a $2.65 billion increase in customer deposits dovetailed by an $832 million increase in banks’ and financial institutions’ deposits.

Examining the sector’s profitability reveals an increase of $22.6 million in the bottom line year on year, indicating a 5.69% rise to $420.1 million, as compared to $397.5 million in the first half of 2006.

The oil riches as well as the central bank’s new regulations imposing minimum capital levels of approximately $142 million by 2010, has encouraged banks to expand into the region. “Jordanian banks are thus establishing operations in countries such as Syria, Algeria, Qatar, Bahrain, or the UAE where the Housing Bank has opened recently,” underlined al-Saqqaf.

Bank of Jordan received a license to begin operations in Syria. The Housing Bank for Trade and Finance, one of Jordan’s largest domestic banks by assets, has already taken majority shares in subsidiary banks positioning itself on the Syrian and Algerian markets.

Forecast

The banking sector has been closed to outside players since the CBJ decided not to grant more licenses for the time being. “We expect consolidation of the banking industry to take place. There is certainly an appetite for mergers essentially due to the implementation of Basel II and the large projects that are emerging in Jordan,” the vice governor pointed out.

The IMF has declared that the CBJ has made significant progress in strengthening the regulatory and institutional framework for the banking sector in recent years with the implementation of Basel II standards underway and the enactment of an anti-money laundering (AML) law in 2007 as well as the establishment of an AML unit in the CBJ. New corporate governance regulations for banks, implementation of the electronic check-clearing system, and publication of the Financial Stability Report are welcome developments.

In al-Saqqaf’s estimate, the new challenges awaiting the banking sector are mainly articulated around a further automation of the industry, more mergers and structured products. In addition, the recent establishment of a Dow Jones index for the Amman Stock Exchange will certainly add more sophistication to the market and contribute to the development of the broader capital market and the deepening secondary debt market.

Syria’s private banks continue to shake up the country’s long stagnant banking sector. Four years after the first private banks entered the market, nine now operate, including the country’s first Islamic firms, on top of the existing five state-run institutions. A further nine have received preliminary licenses to operate in the market which, up until 2004, had been strictly the domain of the state. International credit cards, phone banking services, wider ATM access and tailored personal loans for laptops and automobiles have all been launched over the past 12 months to a public which remains heavily under-banked by regional and international standards. Business is good, with all newcomers again posting strong double digit growth figures. Indeed, Syria’s banking pastures are green enough to have seen every private bank turn a profit by the second year of their operations, a year ahead of industry standards.

“There are few countries in the world, if any, where the private banking sector has been able to generate a positive return on equity in their first or second year of operation,” Bassel Hamwi, general manager of Bank Audi Syria, said. “Syria stands out. What’s more, the growth that the sector has experienced has been overwhelmingly organic. It’s not growth that private banks are deriving from the deposits of Syrians at public banks. It’s coming from money that was under the mattress and is making its way into the formal economy.”

By the numbers

Overall, total banking sector assets rose by 12% in 2007, ending the year at $34.3 billion, up from $30.6 billion at the end of 2006, according to the most recent figures released by the Central Bank of Syria. Public bank assets rose by 4.8% to hit $28 billion, up from $26.7 billion a year earlier. State-owned banks held 81.5% of the country’s banking assets at the end of 2007, slightly down from 87% in 2006. Private bank assets almost doubled over the same period, rising from $3.9 billion to $6.3 billion. No bank, public or private, had released first quarter figures for 2008 by the time of this publication.

Three new private banks have opened to the public in the past 12 months, including the country’s first two Islamic firms. The newcomers include Syria Gulf Bank (SGB), a $65 million joint-venture between United Gulf Bank of Bahrain, Al Fotouh Investment Company of Kuwait, Global Investment House of Kuwait, First National Bank of Lebanon and other several local investors. SGB was licensed at the end of 2006 but, in practice, operated only in the second half of 2007.

The first Islamic bank to open to the public was Cham Bank which launched its services officially in August last year. Cham is a $108 million joint venture between a number of key investment firms from the Gulf — Kuwait in particular — and Syrian investors. The country’s second Islamic institution is the Syria International Islamic Bank (SIIB) which opened its services to the public last September. The bank is a $108 million joint-venture between several Qatari financial institutions, including Qatar International Islamic Bank.

A further nine banks have received preliminary licenses to open. These are the Bank of Jordan, Qatar National Bank, Dubai Islamic Bank, Noor Financial Investment Company, Tadhamon International Islamic Bank, Bank of Baraka-Syria, Global House Group of Bahrain, Lebanon’s Fransabank and Banque Libano-Française, the latter of which will operate under the name of Orient Bank.

Four years after opening her banking sector to private investment, Syria has still been unable to attract the attention of any bank from outside the Arab world. The damage to the country’s business reputation brought about by a heavy US sanctions regime — particularly the targeting of the country’s largest bank, the state-owned Commercial Bank of Syria — as well as provisions in the law which impose an ownership ceiling of 49% on foreign investors are widely held as being responsible for the lack of interest outsiders have shown in the Syrian market. The government has been considering increasing the foreign ownership ceiling to 60% since early last year — giving foreign stakeholders a controlling interest — but just when this will take place remains anyone’s guess.

In other industry indicators, total deposits increased by close to 15% last year, rising from $17.4 billion at the end of 2006 to $20 billion at the end of 2007. Deposits held by state-owned banks — this includes the Commercial Bank of Syria, Agricultural Cooperative Bank, Popular Credit Bank, Industrial Bank, Real Estate Bank and Savings Bank — grew by around 6% in 2007, rising from $14.3 billion to $15.2 billion. Over the same period, deposits held by private banks increased by 54.5%, from $3.1 billion to $4.8 billion. At the end of last year private banks held 24.39% of all deposits, up from 18% at the end of 2006.

Syria’s private sector had deposits of $14.2 billion in the local banking system at the end of 2007, up from $9.7 billion at the beginning of 2005. The private sector is increasingly choosing to do business with private banks and around one-third of all private sector deposits are now held by non-government banks. Government institutions and companies still, however, deal almost exclusively with state-owned banks, although nothing in the law forbids them from working with private banks.

The total loan portfolio of the country’s banking sector grew by around 26%, ending 2007 at $13.4 billion, up from $10.6 billion a year earlier. Loans extended by state banks increased by 20%, rising from $9.9 billion to $11.9 billion over the same period. Loans extended by private banks increased by 94%, rising from $760 million to $1.5 billion.

Holdings of Syria’s top banks (figures in $ billion)

Loans market still weak

Despite the near triple-digit growth rate in the loan portfolios of private banks, Syria’s credit lines remain weak and government dominated. While it had been hoped the introduction of private banks would be the catalyst in transforming the country’s lending market, state-owned institutions accounted for 89% of all loans undertaken by Syrian banks last year.

Complicated lending procedures and weak internal banking practices at the country’s major public lenders, the lack of proper financial records among potential borrowers and the absence of key market instruments such as treasury bills and bonds all make accessing and extending credit in Syria a difficult proposition. The overwhelming majority of deposits at Syrian banks, particularly private banks, are short term in nature (three to six months) which further limits their ability to provide long term loans. A legal environment which holds public bank staff — the major lenders — personally liable for the loans they sign off on should they go bad also acts as a disincentive for granting credit. A lack of legislation regarding repossession rights and mechanisms for solving potential disputes such as conflicting land ownership claims has also been cited by industry players as reasons they have stayed away from providing long term credit, particularly in the form of home mortgages.

“It’s a big issue,” Hamwi said. “We were able to provide long term project financing early on and we take pride in the fact that we have done it for several projects, but it is an area plagued with problems.”

Syrian authorities are, however, moving to create a more favorable lending environment. The introduction of treasury bills and bonds this year should, in theory, provide banks with the tools they need to carry out long term lending. Decree No 174 passed in September 2007 further permitted private banks to offer credit rate margins of plus or minus two percent, instead of the previous half percent either side of the Central Bank rate. The move is expected to decrease lending rates by around 1.5% and stimulate competition among the banks.

The government is also presently drafting a set of laws which will clarify repossession rights and other key issues, as well as pave the way for mortgage financing companies to enter the market. According to the plans, mortgage finance companies will be able to make loans and then sell on packages of customers’ repayments as bonds to other financial institutions — increasing the companies’ access to finance and spreading the risk of default loans among a wider pool of investors. Such companies are not without risk, however, and were largely responsible for the subprime mortgage crisis in America.

Skilled staff in demand

As with other areas of Syria’s rapidly expanding financial services sector, a lack of suitable potential employees continues to be an obstacle to growth, particularly given all new private players are working to expand their branch network coverage. Syrians are increasingly taking over the reigns at the country’s banks, however, and the sector has made it a policy to target expatriate Syrians. “Specifically, we are targeting the Gulf, the United States and Canada,” said Issam Nashawati, Syria Gulf Bank general manager. “Bringing back expatriates from Europe is more difficult as they are generally more settled.”

Financial training inside Syria remains poor — with no training in Islamic banking products provided — and all private banks have commenced internal training programs. “We are bringing in graduates and providing them with considerable internal training,” Nashawati said. “We are focusing on Syrians because they are the future. There is an understanding of this across the industry.” An industry wide ‘gentleman’s agreement’ not to poach staff has generally been upheld by new entrants to the market.

Increasing the number of branches remains the primary key to growth. The number of branches operated by private banks in Syria presently sits at 68, up from 43 in 2006. Banque Bemo Saudi Fransi (BBSF), the country’s largest private bank both in terms of market share and coverage, accounted for close to one-third of all private bank branches with 20 branches presently operating in Syria. BBSF continues to lead the expansion of the private banks into rural and remote areas, opening branches in Hassakeh, Qamishli, Deir el-Zor and Deraa. The International Bank of Trade and Finance follows with 13 branches, up from 10 at the end of 2006. Bank Audi Syria saw the largest relative increase in its network over 2007 and presently operates 10 branches up, from five at the end of 2006. Over a third of private bank branches are located in Damascus, while the balance is mostly spread through Syria’s other large cities of Aleppo, Homs, Tartous, Lattakia and Hama.