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Cocktail of risks

7 Dec 2015 By Hugo Dixon

Turkey’s economy is threatened on many fronts. A row with Russia and the prospect of the Federal Reserve raising rates have coincided with President Tayyip Erdogan’s increasing politicisation of the economy and bad governance. This could prove a toxic cocktail given the private sector’s high debt.

Turkey’s cost of capital is rising. The government’s 10-year dollar bond yield was 5 percent on Dec. 4, up from 4.7 percent a year ago and 4.1 percent just before Turkey shot down a Russian jet last month.

The government isn’t to blame for global investors falling out of love with emerging markets in general or, indeed, for what Turkey claims was a Russian invasion of its air space. But many of the risks Turkey is facing are self-inflicted.

Russia’s muscular response to the shooting down of a Russian bomber jet in November already threatens to create economic costs for Turkey. Among the raft of economic sanctions already announced, banning charter flights to the country and other moves to dissuade tourism will be especially damaging. About 3.3 million Russian tourists visited Turkey last year. What’s more, Russian President Vladimir Putin seems intent on finding other ways of exacting vengeance.

The Russian president may increase support for Kurdish militia fighting inside Syria, something Ankara has warned against. This would infuriate Erdogan whose main goal in Syria is to prevent the emergence of a Kurdish enclave on Turkey’s border. The Turkish president’s Syria strategy is already looking sick, as the West is focusing on fighting Islamic State and not giving priority to Erdogan’s other goal – bringing down the country’s leader, Bashar al-Assad.

Meanwhile, Erdogan has failed to prevent renewed fighting with the Kurdistan Workers’ Party (PKK) inside Turkey, although the Kurdish militia group is also responsible. He abandoned peace talks with the group earlier this year, after which violence flared up.

The Turkish president benefited from the breakdown in the peace talks because the instability helped his party win a majority in November’s election after it failed to secure one in an earlier poll in June. But the renewed violence creates a strong sense that the country is fighting on multiple fronts, diminishing its appeal to investors.

As if this were not bad enough, Erdogan has increasingly politicised the economy. After taking power in 2002, he followed prescriptions laid down by the International Monetary Fund in the wake of its last financial crisis.

But in recent years, Erdogan has undermined the independence of the central bank by opposing higher interest rates, so much so that the country has little credibility for fighting inflation which hit 8.1 percent last month. Meanwhile, the Turkish lira has dropped more than a fifth against the U.S. dollar in the past year, putting pressure on companies that have borrowed in hard currency.

Since the November election, there have been further worrying signs. Ali Babacan, who had been deputy prime minister in charge of the economy and was seen by investors as a safe pair of hands, wasn’t reappointed. His replacement, Mehmet Simsek, is well regarded but not considered a heavyweight. What’s more, Erdogan’s son-in-law, Berat Albayrak, was made energy minister.

The Turkish president is also becoming increasingly authoritarian. The editor of a leading newspaper was put in jail last month for publishing an article that Erdogan deemed espionage, even though there has yet to be a trial to test the claim. It’s not just freedom of the press that has been curtailed. So has the independence of the judiciary, while corruption is widespread, according to the European Commission.

Instability and weak rule of law is bad for business. There has also been capital flight. Turkey is vulnerable because it has been consistently running a big current account deficit – forecast to be 4.5 percent of GDP this year by the IMF – and needs foreign funds to plug the gap.

The economy is still expected to grow at about 3 percent largely because construction and domestic consumption have held up. However, this depends on credit – with households borrowing to buy homes and developers borrowing to build them.

Housing investment is fuelled by rising property prices, and pushes them still higher. But if they stop going up, the debt that has backed purchases could weigh heavily on the economy.

The only good recent piece of news is that the European Union has agreed to reenergise talks about Turkey joining the bloc. In theory, that could lead to a raft of political and economic reforms that put the country on a positive new trajectory, as Ankara strived to meet the conditions of membership.

Unfortunately, EU leaders would struggle to convince their own voters to welcome Turkey as a member; and Erdogan doesn’t seem to have any intention of making the required reforms. Turkey may need to suffer a deeper crisis before this changes.


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