Ben Aris in Istanbul -
"It looks like the world's economy is going to slow down and that is good news for Turkey. Which other country in the world can say that?"
In a world full of long faces, it's always refreshing to meet a finance minister who is chipper and full of optimism, and in many ways Mehmet Simsek embodies the profound change that Turkey is going through at the moment. He is young, eloquent and Kurdish - something that would have been unthinkable a few years ago. Born to poor and illiterate farmers in the somewhat incongruously named city of Batman in southeastern Turkey, after graduating with a degree in economics Simsek spent many years working at Merrill Lynch in London and UBS in New York, before joining the government in 2007. He was appointed finance minister during the depths of the global economic crisis in May 2009.
Turkey has been one of the winners in these desperate times. Thanks to the severe banking crisis that Turkey suffered at the start of this millennium, its banking sector was probably best positioned to withstand the latest financial storm to hit the global banking industry. The latest piece of good economic news was that, while Europe suffers a series of debilitating credit rating downgrades, in September Standard & Poor's raised its long-term local currency rating on Turkey from 'B+' to an investment-grade 'BBB-'.
The economy is barreling along, up 10.2% in the first half of this year, overtaking China to become the fastest growing major economy in the world. But that has also been the source of Simsek worst headache: fast growth has sent domestic demand soaring by 16% in the first half of this year, sucking in imports. Add to that the recovery of oil prices to over $100, and Turkey's current account deficit has mushroomed to over 9% of GDP, or more than $75bn this year.
Big current account deficits are a primary cause of crises and a recurring one for Turkey. Despite having an export-driven economy, Turkey only makes things that are low on the value-added chain and so doesn't earn enough to pay for the imports its emerging middle classes are increasingly demanding. Not having any oil or gas production only makes the problems worse, hence the plans to go nuclear, the push for renewables and the speculative drilling in the Black Sea.
The external financing gap is now about $75bn, but including the short-term debt coming due soon adds another $132bn to its funding needs, calculates Timothy Ash, head of strategy at Royal Bank of Scotland. "With forex reserves standing at only around $90bn, this underlines Turkey's key vulnerability - a low reserve/external financing ratio of less than 50%," Ash said in a recent note.
Indeed, while S&P raised Turkey's local currency rating, it left the foreign currency rating at 'BB' (ie. two notches behind investment grade) because, as Ash argues, the agency simply couldn't move on that one while the country is still running a wide current account deficit and suffers a very wide external financing gap.
Analysts at Capital Economics, Neil Shearing and William Jackson, also sounded alarm bells in a report at the start of September pointing to the large current account deficit, saying it makes Turkey, "susceptible to changes in external borrowing conditions and investor sentiment." Given the global economy is likely to slow down next year, Shearing and Jackson predict that Turkey's economy will "capitulate" to the point where GDP will contract by 1% in 2012.
Ash is not quite so pessimistic, pointing out most of the debt is trade financing or loans to the robust bank sector that are relatively easier to restructure. Still, Turkey's total external financing needs are $70bn-80bn more than in the first wave of the crisis in 2008 and the countries hard currency reserves have only risen by $20bn since then.
Smiling, happy, shining people
In essence, it seems that Turkey has a built-in self-destructive mechanism that always kicks in whenever the economy booms, and the only way to break this cycle is to implement deep structural reforms. But while Simsek appears unfazed by these problems, he stresses he takes them very seriously.
Speaking with bne at September's East Capital Turkish investment summit, Simek says the slowdown in Europe will take the steam out of the country's blistering economic growth, as will a 20% devaluation in the lira. "Analysts call the current account deficit Turkey's soft belly, but it is a problem of the past and the chances are that the external balance will adjust," says Simsek. "The probability of a soft landing is very high."
Simsek argues that the path ahead is clear and that because Turkey has been so badly burnt in the past, it has the political will to see the necessary reforms through. "Stabilising your debt/GDP ratios is easy, as all you need is growth, primate surpluses or a lower cost of borrowing," Simsek says somewhat flippantly.
But he has been delivering nonetheless. While most of Western Europe labours on Dante's first circle of purgatory, bowed by massive debts, the government has been running fiscal surpluses of over 5% for years and brought the debt/GDP ratio down from 80% a decade ago to 40% this year.
Indeed, as the 2008 crisis hit, many of these policies were revived and this year the state ran an 8% surplus despite the government having to face a general election. Likewise, the deficit target for this year is 2.1%, but the government is confident that it will come in at much less; over the first eight months of this year, the budget was actually in surplus. "This is beyond fiscal discipline, but we still need to bring the current account to a level that is sustainable," says Simsek. "But we are committed to fiscal discipline and this hit is a one-off. Given the mood today, it feels like we are already in a modern depression, but in reality things are not that bad. We expect a bout of slow growth in the next years rather than a full-on recession."
The numbers are bad, but Simsek has certainly put Turkey into a much stronger position than most of Europe's developed economies. However, these are only short-stop measures and for Turkey to really flourish, it needs to deal with its basic problems: low-quality production and the need to import all its energy.
Fueling the future
Here too, Simsek has a firm grasp of what needs to be done. Clearly energy imports are the country's Achilles heel: every extra dollar a barrel of oil costs adds about $2bn to Turkey's current account deficit and with the medium-term forecasts for oil prices in the range of $80-100, this is bad news for Turkey (although Capital Economics has been predicting for two years that oil will fall to $50).
The government's strategy is to reduce its dependence on imports by building out new generation capacity in multiple directions, as well as obliging gasoline and diesel to contain a minimum 3% of domestically produced biofuel by 2014-2016.
Turkey has recently agreed a deal with Russia to build a nuclear power plant, boost its wind generation, and is planning to tap its hydroelectric power potential by doubling capacity in the next decade. "We have very good hydropower potential and we are only using a third of what is available at the moment," says Simsek. "The government had 1,500 hydropower power projects in the drawer, but not the resources to put them into place. So we just gave these projects to the private sector."
The second plank is to move Turkey's exports up the value-added chain by investing in its young population: half the population is 28 years old and the biggest beneficiary from federal spending in the 2010 budget was the Ministry of Education.
Turkey is also building relations with the Middle East to diversify its export markets, while Russia has become one of Turkey's most important export markets, especially for agricultural products like fruit, venegtables and chicken.
However, all these measures will take at least a decade to really have an impact on Turkey's fundamental problems. Still, Simsek is the man with a plan and he brims with a confidence that largely rests on the Turkish people themselves. "We cannot maintain the current high levels of growth forever, as we don't have the domestic savings base to fund it," says Simsek. "However, we can comfortably sustain growth of 5-6% for the next one or two decades thanks to our very favourable demographic situation."
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