Practical analysis for investment professionals
09 April 2014

The Turkish Economy Has Survived Crises Before, Elections are Key to Investor Confidence

Turkey, a member of the G-20 and one of the largest emerging markets, has been making headlines recently for its economic and political turmoil. To get a local perspective on the situation, we spoke with Attila Koksal, CFA, a seasoned investment professional based in Istanbul. Koksal is chairman of the Turkish Capital Markets Association, and he is a member of the CFA Institute Board of Governors. He has also been associated with a number of other institutions such as Borsa Istanbul. This interview, however, is in his personal capacity as an investment professional.

CFA Institute: What has been the impact of political instability and a challenging macroeconomic environment on the Turkish economy so far?

Attila Koksal, CFA: Until mid-2013, Turkey has been among the most favorite venues for global investors. After the 2001 crisis, the country experienced steady growth every year, except for 2009, averaging an annualized GDP growth rate of 4%.

Turkey’s strong demographic structure, its important geopolitical position, and a decade of political stability placed Turkey among the most favored markets for strategic and portfolio investors. Between 2005–2013, the country attracted more foreign direct investment than what was received since the foundation of the Turkish Republic in 1923 until 2005.

However, recent developments, i.e., Fed tapering on the global scale, the fight between the government and the Gülen movement, and corruption allegations against the government, distorted the Turkish story. The Turkish lira lost a quarter of its value, the Istanbul Stock Exchange index declined 40% in USD terms from its peak in May 2013, and short-term interest rates climbed to 11% levels where inflation expectations for 2014 are at 8%. Consumer confidence dropped, and 2014 GDP growth expectations are revised down to 2% levels, which will result in three consecutive years of below average growth.

Surely, almost all emerging markets face similar problems in 2014. However, uncertainties in Turkey are more pronounced as there will be three elections in the following 15 months, namely local elections in March, presidential elections in August, and general elections in June 2015.

In one of our recent opinion polls, respondents said that among the largest emerging markets, Turkey is facing the most difficult economic challenges. How would you comment on this result?

Recently, Turkey is classified among the so-called “Fragile Five.” Members of this group are Turkey, Brazil, South Africa, India, and Indonesia. Their common characteristics are reliance on foreign capital, large current account deficits, and their vulnerability to Fed tapering and reduced investor confidence in emerging markets.

Fitch Ratings also recently announced that “Turkish corporates are the most exposed among EMEA emerging markets to a scenario of slowing growth, rising interest rates and a persistently weak local currency.”

After a decade of steady growth, it is highly likely that the Turkish economy will experience a slowdown in 2014 and 2015. The Turkish government already took precautionary measures against the growing current account deficit in 2012. At its peak, CAD was 9.7% of the GDP. In 2014, that figure is expected to decline to 5.4%. Turkish households indebtedness is at 55% of household income and gross savings are only 12.6% of the GDP. In the following years, Turkey will have to focus on its macroeconomic imbalances and take further precautionary measures.

Hot money and short-term foreign debt are often blamed during such volatile economic situations in emerging markets. What can you tell us about these two in the Turkish context?

As you know, between 1980 to 2005, Turkey went through a unique “strato-inflation” environment in which inflation averaged above 50% for more than two decades. To finance sticky budget deficits, government bonds offered real yields as high as 25–30% throughout that period. No other country in the world ever had a similar experience. Throughout that period most of the foreign investment in Turkish assets (naturally) was in the form of “hot money,” and the Turkish economy was extremely vulnerable to internal and external shocks. Inevitably, Turkey went into a major financial crisis in 2001 which wiped out almost one third of the Turkish banking system. After 2001, we gradually reduced the budget deficit, restructured our fiscal system, and strengthened the surviving banks’ balance sheets above global norms. As a result of these structural measures, the 2008 global crisis did not have a significant effect on the Turkish economy.

Since 2005, the composition of foreign investors changed and long-term investment inflow increased dramatically. Energy, manufacturing, food and beverage, retail, financial services, and healthcare sectors received substantial direct investments. We have also seen significant foreign investor appetite for the long term debt of Turkish banks and corporates.

Turkey is not as vulnerable to short-term fund outflows as in the past. But nevertheless, the current environment presents a important challenge to the Turkish economy as it does to other emerging markets.

Are there aspects of the economic situation in Turkey that are going relatively under-emphasized in international news media?

As Mark Mobius pointed out in a recent interview “the long-term investment case for emerging markets has not dramatically changed.” In the case of Turkey, a majority of foreign investors still believe that the growth potential, favorable demographics and the entrepreneurial spirit of the Turkish economy will prevail over the long term.

One has to note that my generation has seen many crises in the past. All emerging markets crises in the 1980s and 1990s (Asian crisis, Gulf crisis, Russian crisis) had significant negative effects on the Turkish economy. Our own crisis in 2001 was also quite unique. To deal with this crisis, we devalued our currency and increased the interest rates and taxes. Everybody paid a huge price and became poorer overnight, but we managed to survive by ourselves only with a little help from the IMF.

Turkish economy proves to quite resilient to crises, and Turkish business managers have decades of crisis management experience.

Having learned a big lesson in 2001, Turkish banks gradually strengthened their capital adequacy ratios. They also enjoyed 10 years of strong growth (CAGR 20%) and high profitability. Even though we have some challenging years ahead of us, the local banking system is adequately capitalized to support the Turkish economy and Turkish corporates in the coming years.

In your view, are local investors based in Turkey well-diversified internationally or are they carrying substantial Turkey-specific risk in their investment portfolios?

The majority of Turkish investors were born in a period of high inflation. They were raised and spent most of their careers in an inflationary environment. They have a unique ability to survive the crises. The average Turkish household wallet consists of foreign exchange, gold, and short-term bank deposits. Equity investments are less than 5% of the total. As one can see, this portfolio is basically a protection tool against crises and/or inflation. During the last 10 years, the Turkish economy grew steadily, equities and bonds performed quite well, the Turkish Lira appreciated against gold and foreign currencies. The average Turkish investor did not benefit from these developments. However, recently, the average Turkish investor outperformed all equity and fixed-income benchmarks as the Turkish Lira was devalued, gold (which is locally quoted in USD) appreciated against the TL, and interest rates went up. I cannot say that local investors are well-diversified internationally, but, they maintain a portfolio that protects them against local crisis.

What do you think it will take to restore investor confidence in Turkish lira, its markets, and its economy at large?

As I mentioned earlier, at the macro level, Turkey presents a great long-term investment case. Turkey is the 17th largest economy in the world. Half of its population of 76 million is under the age of 30, and the Turkish economy is expected to grow at an average annual growth rate of 5.2% until 2017, according to OECD estimations. However, current political turmoil caused a loss in investor confidence both locally and internationally. We have three consecutive elections in 18 months. The result of these elections will be the key to the restoration of investor confidence. Besides, regardless of the outcome of these elections, the Turkish government needs to assure foreign and local investors that it will maintain the rule of law in the country, fight against corruption, and continue providing a business-friendly environment and a liberal investment climate.


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Photo courtesy of Attila Koksal

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About the Author(s)
Usman Hayat, CFA

Usman Hayat writes about sustainable, responsible, and impact investing and Islamic finance. He is the lead author of "Environmental, Social, and Governance Issues in Investing: A Guide for Investment Professionals," and the literature review, "Islamic Finance: Ethics, Concepts, Practice." He is interested in online learning and has directed three e-courses for CFA Institute: "ESG-100," "Islamic Finance Quiz," and "Residual Income Equity Valuation." The other topics he writes about are macroeconomics and behavioral finance. Previously, he was a content director at CFA Institute. He is a former executive director at the Securities and Exchange Commission of Pakistan (SECP). He has experience working in securities regulation and as an independent consultant. His qualifications include the CFA charter, the FRM designation, an MBA, and an MA in Development Economics. His personal interests are reading and hiking.

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