COMMENT: Turkey’s silent economic revolution and the new sovereign wealth fund

COMMENT: Turkey’s silent economic revolution and the new sovereign wealth fund
Turkish Airlines is one of the state-owned companies put under the new sovereign wealth fund holding.
By Cagdas Cataltas of Control Risks March 15, 2017

All eyes are on Turkey’s controversial referendum where President Recep Tayyip Erdogan will ask the people on April 16 for his powers to be extended to make him an “executive president”. However, little attention has been paid to the silent economic revolution that is playing out in the background.

Four days after last year’s failed coup of July 15 the Justice and Development Party (AKP) declared a state of emergency, which has been renewed three times since then. This state of emergency gives the government sweeping powers to rule the country by executive decree, bypassing the normal parliamentary process, and AKP has made use of them.

The decrees are supposed to alleviate problems linked to the coup. Fifteen decrees have been issued as at the time of writing, covering a range of issues but several have nothing to do with the coup at all.

One such decree, passed in August 2016, launched the Sovereign Wealth Fund of Turkey (SWFT). In early February, several state owned companies were transferred to the fund, including: the National Lottery Administration, the Turkish Petroleum Corporation (TPAO), Ziraat Bank, Turkish Post (PTT), the Satellite Communications and Cable TV Operations Company (Turksat), Eti Mine Works, the General Directorate of Tea Enterprises (Caykur), horserace operator the Turkish Jockey Club (TJK), the Izmir port, parts of the Istanbul Stock Exchange (BIST), Turkish Airlines (THY), Halkbank, Turkish Telecom, as well as 46 pieces of valuable land, most of which are in Antalya, a popular tourist destination.

Shifting economic policy

The SWFT and its collection of valuable assets mark a significant shift in AKP’s economic policy. Part of the party’s economic success (which has been increasingly questioned in the last few years) has been due to privatisations, amounting to well over $70bn since 2002. The government also made use of both the Build-Operate-Transfer model and Public Private Partnerships to realise its infrastructure projects, such as highways, bridges and city hospitals. Indeed, the Turkish privatisation authority announced on August 5 that the National Lottery Administration would be privatised – an announcement still available on the authority’s website. Instead it is now a part of SWFT.

This begs the question what the new fund will do. The aims are listed in the executive decree that established it and include: Supporting strategic sectors and companies, via investment in strategic sectors and companies; financing mega projects including highways, the third Bosphorus bridge, Istanbul’s third airport, Canal Istanbul (which aims to create an artificial canal parallel to the Bosphorus) and a nuclear plant; and stabilising capital markets, paving the way for the government to invest abroad, thus creating employment and encouraging Islamic finance.

What is not clear, however, is how the fund will achieve these somewhat contradictory goals. One thing that is evident is that the SWFT has little oversight: it will neither be regulated by the financial regulator, the Capital Markets Board, nor audited by the Treasury or the Court of Auditors, and it is not subject to public procurement or competition laws.

The fund is either exempt or almost exempt from income tax, corporate tax, stamp duty, and the special tax on loans. All the companies that have been transferred to SWFT were subject to most of these laws and taxes before being taken into SWFT. It has also been given the ability to buy, sell and issue bonds, as it is subject only to commercial law. About the only supervision the fund has is a requirement to have an independent audit of its financials.

One possibility is that the fund has mainly been established as a source of funding for the government’s mega infrastructure projects. In the aftermath of the failed coup and in the absence of macroeconomic reforms, all major ratings agencies downgraded Turkey’s credit rating making it harder for AKP to raise the large sums these projects need. It is possible that the government will use the SWFT to use its ownership of its valuable companies as collateral to raise debt to fund the government’s projects.

The fund will also earn a significant income from its holdings. Dividends from the companies transferred to the fund in 2015 totalled approximately TRY1.5bn - TRY2bn (£0.32bn - £0.43bn). While a similar amount may be at the disposal of the SWFT managers this year, there will consequently be an equally sized gap in the treasury.

Sovereign wealth funds are often, but not always, used by countries with budget surpluses, say experts – either due to natural resources or a well-established pension system. Given Turkey’s chronic budget deficit, the fund won’t play the role of a conventional sovereign wealth fund: collecting excess revenues from a country’s bounty and investing them for the public good. What makes SWFT a sovereign wealth fund will also depend on if the bonds issued by the portfolio companies will be guaranteed by the state.

Given SWFT’s wide mandate, it is equally possible that the fund will be involved in privatisations. In theory, it could acquire any asset up for sale (and indeed already owns one that was supposed to be sold in a privatisation bid). In the case of the National Lottery Administration, it could make any administrative, managerial and financial changes it deemed fit and then sell the asset to a chosen buyer at any price. At present, none of these decisions made by the fund would be subject to public scrutiny, which is normal in the privatisation process. While such practices could create many opportunities for foreign investors, these opportunities would also come with potential compliance issues.

Potential compliance risks

The International Working Group of Sovereign Wealth Funds (IWG), an international club of funds, met in Kuwait City in April 2009 and reached a consensus on the establishment of an International Forum of Sovereign Wealth Funds and agreed to abide by the Santiago Principles, which set transparency and best practice guidelines, as the blueprint for compliance regarding sovereign wealth fund activities.

It appears that some of those principles will be vital for the SWFT to have any chance of being successful, including principal 3, which reads: “Where the SWF's activities have significant direct domestic macroeconomic implications, those activities should be closely coordinated with the domestic fiscal and monetary authorities, so as to ensure consistency with the overall macroeconomic policies.” And principal 6, which advocates “the governance framework for the SWF should be sound and establish a clear and effective division of roles and responsibilities in order to facilitate accountability and operational independence in the management of the SWF to pursue its objectives”.

Whichever strategy the SWFT chooses, international investors should keep an eye on the adoption of a transparent and inclusive policy of governance for the fund. Any signs of mismanagement or debt binges in the pursuit of immediate enrichment will lead to the funds eventual failure.

This comment was by Cagdas Cataltas, a Associate Director for Western Europe at Control Risks (@GBCagdas).