Can Turkey still afford its megaprojects?

Can Turkey still afford its megaprojects?
Istanbul is the centre for many of these megaprojects.
By Menekse Tokyay in Ankara May 19, 2016

Squeezed by the rising threat of instability and slowing economic growth, Turkey has nevertheless set its sights on huge infrastructure projects currently under construction. But the ongoing political and economic problems could leave their mark on the implementation and completion of these projects in due time, and shake the credibility of Turkey’s government and President Recep Tayyip Erdogan.

One of the biggest questions is whether the country can still afford such megaprojects worth a combined almost €22bn over the coming years; the issue of 100% state guarantee for these major projects, which cost more than $1bn, is considered one of the sources of friction between President Erdogan and his outgoing prime minister Ahmet Davutoglu, who wanted to cut the share of such a guarantee to 80% but instead ended up losing his job.

The megaprojects include Istanbul’s third airport with an annual passenger capacity of 150mn; a third bridge over the Bosphorus Strait; the Izmit Bay Bridge, the world’s fourth longest suspension bridge, that will connect Istanbul with the Aegean province of Izmir; the underground Eurasia Tunnel that will link Istanbul’s European and Asian sides by road; the Gebze-Halkali commuter train connection in Istanbul; the Baku-Tbilisi-Kars Railway; and lastly the 14.7km-long Ovit Highway Tunnel that will connect Northeastern Anatolia with the southeastern provinces, and all the way on to Iran and Central Asia. 

The third airport in Istanbul, being built by the Cengiz-Kolin-Limak-Mapa-Kalyon consortium, a joint venture of Turkish companies close to the government, is expected to be opened in February 2018. Once operational, Istanbul Ataturk Airport will be closed to commercial air transport. The city’s new bridge, carried out by a consortium of the Turkish company Ictas and the Italian company Astaldi, is set to be accessible this year in August. And Izmit Bay Bridge, constructed by a consortium of Turkish companies of Nurol, Ozaltin Makyol and Gocay Construction as well as Italy's Astaldi, is also expected to be opened in the next two months. The other projects are in the early stages and set to be launched over the coming few years.

In terms of cost, the third airport of Istanbul is expected to cost €10.3bn, while Izmit Bay Bridge is estimated at €9.6bn. The underground Eurasia Tunnel will be completed at a cost of €1.14bn, while the Ovit Tunnel is put at €307mn. The cost of the Gebze-Halkali commuter train connection has not been disclosed yet, but the project is facing delays due to an increase in unforeseen costs. And the estimated cost of the Baku-Tbilisi-Kars Railway project is €526mm.

To a large extent, these megaprojects can be seen as an effort by Turkey to position itself as a trade and transportation centre, as well as the biggest air transfer hub between Europe and the Middle East and Central Asia. Turkey aims to receive 200mn airline passengers a year, and the new airport of Istanbul is expected to contribute to this target by providing links also with Asia and Africa. The projects are likely to increase the international appeal of Turkey, and especially of Istanbul and its environs where many of them are located, in competing with other economic hubs around the world.

These billion-dollar projects – since the Justice & Development Party (AKP) of Erdogan came to power 13 years ago it has splurged around TRY253bn ($90bn) on such endeavours – also represent the grand ambition of the country’s president, who sees them as a means to project Turkey’s image as a country regaining its power in the world since the collapse of the Ottoman Empire over a century ago, especially with the republic gearing up to celebrate its centenary in 2023. Case in point is Kanal Istanbul, a 45-kilometre man-made waterway drilled across the European edges of Istanbul, to connect the Black Sea with the Marmara Sea – a project called “crazy” even by Erdogan himself. “Never mind the ‘Putinisation’ of Erdogan, never mind sultans – now he seems to be channeling Ramses II,” says Suna Edem, a columnist for bne IntelliNews.

There’s also the economic argument. Turkey’s transport minister, Binali Yildirim, who has been picked by Erdogan to succeed Davutoglu as PM, recently claimed that the ongoing infrastructure projects have created around TRY8.6bn ($3bn) for the economy and given employment to more than 65,500 people.

Yet the economic effects of such megaprojects and their associated state guarantees are increasingly coming under the microscope of economic observers.

At the end of April, Fitch Ratings warned about the rapid rise in private-sector debt in emerging markets like Turkey, where foreign-currency debt was highest as a share of GDP at 41%. Likewise, the International Monetary Fund warned in February about private sector balance sheets becoming “more stretched” in recent years. “In addition, the increasing use of guarantees and [public–private partnerships] to finance investment entails contingent liabilities that may materialize during a downturn. Their rapid growth requires stronger central oversight, approval and disclosure,” the IMF said in the statement. “A more comprehensive overview of the public sector fiscal position, transactions and risks, could also be supported by enhancing the coverage of fiscal reporting, including on pension and PPP liabilities, and publishing a fiscal risk statement.”

Turkey's slowing economy – the World Bank expects growth to slow to 3.5% in 2016 from 4.0% in 2015 – as well as the growing threat of terrorism attacks by the Kurdistan Workers Party (PKK) and Islamic State could lead to rising costs of financing for these projects due to higher risk premiums. In some cases, this could result in postponement or even the cancelation of some projects, critics warn.

Current problems

Considering the impact that these megaprojects have over foreign currency flows to the economy, some question how Turkey can keep its current account deficit –  a perennial problem for Turkey – under control. “In order to decrease the current account deficit, these mega-projects should sell services in foreign currency, but to have any meaningful effect these services should be related to export and tourism,” says Mustafa Sonmez, an economist. “Among these projects, only airports have the potential to bring some foreign currency, but still only to a limited extent.”

According to Sonmez, there is a risk that private companies involved in these projects will have to increase their already high external debt positions by borrowing abroad. “They can only contribute to financing the foreign exchange gap if they attract foreign direct investment into these projects,” he says.

Sonmez also adds that especially after 2011, these mega-projects were mainly undertaken by companies close to the ruling AKP, and that such clientelism badly impacts on the country’s credibility and investment climate in the eyes of potential domestic and foreign investors.

Erinc Yeldan, professor of economics at Bilkent University in Ankara, says that these projects are ultimately investments on basically non-tradable services, with a severe geographical bias. “Our not very old experience with the Asian and the Spanish crises have revealed that economic booms based on construction and speculative-led expenditures on such extravagant investments leads to unsustainable booms and lays the grounds for a crisis very rapidly, often in the form of a financial meltdown,” Yeldan tells bne IntelliNews.

“Turkey is suffering from a severe deceleration in its fixed investments, with the rate of growth in its fixed investments being virtually stagnant over the last three years,” he adds.

Yeldan also notes that with its faltering investment performance, the rate of growth of Turkey's industrial activity has also slowed down with a consequent rise in structural unemployment.  “Cast under the severe constraints of a current account deficit, the extravaganza of megaprojects-driven speculative growth signals serious warnings of instability a la Spanish and Asian style,” he underlines.