The term “sweeping powers” is not used idly when it comes to the executive presidency granted to Turkey's Recep Tayyip Erdogan by April’s contested referendum. But it is what the outspoken president might do with those powers that remains foremost in the minds of foreign investors currently trying to assess if Turkey remains a wise play. Any further signs that the rule of law and property rights are under threat could send many international players scurrying for the exit.
For any foreign trader or investor of a nervous disposition, Erdogan is not an easy host to contend with. His regular talk of how high interest rates cause inflation may just be bizarre, but the purge he unleashed against many business people suspected of being connected to the Gulenists he claims were responsible for last year’s failed coup – more than 800 Turkish firms, worth some $10bn, have been seized – is simply too scary to contemplate. Even the stock exchange has been targeted among the at least 40,000 people arrested over alleged links to the coup plotters, with warrants issued for a total of 102 sacked employees.
But Erdogan is no fool. He owes much of his success in politics to strong economic growth, while Turkey remains exposed to external financing – gross external financing needs are around 25% of GDP – and around half of Turkish exports are bought by EU consumers.
He is also not a statist. There is no indication he wants to build a large government sector to dominate the economy. Quite the reverse: Erdogan believes private businesses must be the driving force. Whatever his bluster, many analysts expect him to tread carefully from now on.
Turkey has already received some gentle warnings from foreign partners. On May 8, Turkish Economy Minister Nihat Zeybekci was in Berlin meeting his German counterpart Brigitte Zypries. The Germans, like the Dutch, have remained conciliatory despite Erdogan’s nationalist jibes against the EU during the referendum campaign, which reached such a point he exclaimed that Europe had become a “rotting continent” that is “the centre of oppression, violence and Nazism”.
Zypries pointed out how Germany needs “clear assurances about legal securities”, adding: “The rule of law is a central requirement for the German government and German industry. Companies need reliable framework conditions to make investment decisions.”
Encouragingly for those investing, or minded to invest, in Turkey, the post-coup purge has not been widened to include foreign companies or the country’s largest business conglomerates, such as Koc Holding and Sabanci Holding, both of which are seen as symbols of the integration of the Turkish economy with global capitalism.
Even the biggest businesses in Turkey felt somewhat stranded on the referendum battlefield during the fraught build-up to the vote, and the business climate has become thoroughly politicised, but tellingly, there was no targeting of members of the staunchly pro-EU business group, Turkish Industry and Business Association (Tusiad), long seen as the representative organisation of Turkey’s secular business elite.
The ruling Justice and Development Party (AKP) has historically had an uneasy relationship with Tusiad, but the targets selected in the post-coup crackdown so far suggest that the government does not intend to use the ongoing state of emergency as a pretext to go after business circles it does not get along with.
Ministers have argued that the executive presidency is needed to provide swifter, more efficient economic stewardship. In the referendum campaign they pledged to carry out numerous structural reforms in production, taxes and severance pay, and to launch new financial instruments to restart the engine of vigorous economic growth.
Deputy PM Mehmet Simsek, a well respected former investment banker and finance and economy minister, has repeatedly said that structural reforms would be the top priority of the government after the referendum.
However, Erdogan has had to deny speculation that there will be a cabinet reshuffle, which could affect Simsek. The question is whether Simsek, even if he keeps his post, will have the power to pursue those much-needed but long-delayed reforms.
Many analysts warn that Ankara will remain preoccupied with other pressing issues, such as Turkey’s troubled relations with the EU and the US, the Syrian conflict and transition to the presidential system, and won’t have much time to focus on the reforms.
S&P Global Ratings has said that legislation supporting the move to the executive presidency is likely to dominate the government's agenda over coming months and that, “this could delay the implementation of structural reforms to wean the economy off its dependence on foreign financing”.
It has also warned about the erosion of institutional independence. “Turkey's institutional settings are weak… In our view, this is characterised by increasingly centralised decision-making processes with weakening checks and balances and impaired transparency,” it concluded.
So far, portfolio investors seem to have been relieved by the referendum outcome. The lira, which last lost 17% of its value last year, has become more stable: the currency gained 2% against the greenback between April 14 and May 12 to trade around TRY3.595.
The main stock exchange index, the BIST-100, has risen around 6% over the same period to trade around record levels of 95,500. Total inflows into Turkish equities have topped $1.24bn since the start of the year.
The yield on the 10-year bonds declined by 16bp to 10.70% over the period as prices rose. Central bank data recently showed that there has been an inflow of $1.74bn into Turkish government debt securities in 2017 to date.
But too much waiting around for reforms my not go down well. Atilla Yesilada, an adviser at GlobalSource Partners, says that until the ruling AKP demonstrates through its actions that its desire to uphold democracy and institute economic reforms holds true, Turkey has no story for portfolio investors.
“I think financial investors will buy cheap valuations, and sell when Turkish lira-denominated assets reach valuation parity with emerging market averages. It’s a valuation play,” he told bneIntellinews last month, commenting on the Istanbul stock market rally seen after the April 16 popular vote.
There are also some worrying signs of economic dislocation out there. On May 8, in an Istanbul interview with Bloomberg, Ersin Ozince, chairman of Turkey’s largest-listed lender by assets, Turkiye Is Bankasi, said that Turkish banks’ funding costs were rising, endangering government efforts to engineer a credit boom. “Capital erosion is the most important issue in the Turkish banking industry, because capital has become the most important limited resource,” he said.
Despite some government measures, Ozince said Turkish banks were essentially reliant on foreign financing to spur domestic growth and added that he was concerned about declining interest from foreign banks in their Turkish units. “I’m not sure foreign banks are happy about their operations in Turkey. They don’t seem to have as much appetite as they once did, and I can’t say it makes me happy to see some of them trying to leave,” he said in the interview.
Turkey’s treasury, meanwhile, under pressure to keep up higher spending to bolster growth, has been on something of a borrowing binge to compensate for a widening budget deficit. The annualised cash budget deficit has swollen to a record of more than TRY60bn ($16.7bn) and the government has exceeded its 2017 foreign borrowing target already, with the amount borrowed through May higher than that borrowed in all of 2015 and 2016, according to Bloomberg calculations using official data.
Looking longer term, there are clouds over the outlook for foreign direct investment. FDI inflows into Turkey reached a record $22bn in 2007. Already by last year, they had fallen to $12.3bn, 30% down on 2015, and some big foreign investors are expressing doubts over the future.
The European Bank for Reconstruction and Development (EBRD), which held its annual meeting in Cyprus this week, invested more in Turkey last year than in any other country of operation. But the development bank says the country is facing “investor uncertainty in the context of the unstable geopolitical environment and a perceived deterioration of institutional independence”.
It has cut its growth forecasts for Turkey – it now projects that growth will moderate to 2.6% in 2017 from 2.9% in 2016 – and expects to make less investment this year. . “I would be doubtful if we get near the €1.9bn mark this year, because the political context... has an impact on market sentiment,” EBRD president Sir Suma Chakrabarti told the bank’s annual meeting in Cyprus on May 10.