Turkey’s Fragile Success

Turkey’s Fragile Success

With equity markets in advanced economies treading water and low-risk bonds offering piddling interest, it’s not surprising that investors have rushed back to emerging markets. And where better to head than Turkey, whose economy briskly rebounded from a nasty recession in 2009 to clock Asian-style growth, exceeding 8 percent in both 2010 and 2011.

Where, indeed? The transition economies in central Europe have not grown even half as fast as Turkey in recent years. And while a handful of economies in the Middle East and North Africa seemed to get their acts together in the last decade or two, geopolitical risk in the wake of the Arab Spring has left investors in pause mode. But 2012 isn’t looking much like 2010 or 2011 in Turkey, and there’s reason to believe the bloom is off the rose.

This decidedly mixed economic news is forcing analysts to take a closer look at Turkey’s economic fundamentals. And what they’re seeing are weaknesses that have long lurked behind the curtain. Turkey’s oversized current account deficit – 10 percent of the GDP in the boom years – makes the economy dangerously dependent on the mood of foreign investors. Meanwhile inflation remains stubbornly high, threatening to climb into double-digit territory again. The recent price hikes in gas and electricity strengthen this view.

To better understand the Turkish growth story let’s go back to the banking crisis of 2001, which proved to be an effective wake-up call. With the help of a massive loan from the IMF, Economic Affairs Minister Kemal Dervis pushed through a host of reforms ranging from commercial bank restructuring to central bank autonomy to the elimination of restrictions on foreign direct investment. And when the ruling Justice and Development Party (AKP) came to power a year later, it continued along the lines laid out by Dervis and the IMF. Thus while the AKP would like to take credit for the economy’s success in the last decade, its real achievement was to have the sense not to rock the boat built by Dervis.

Actually, there is less credit to spread around than is generally assumed since the Turkish economy faces some serious problems. Consider the aforementioned large and chronic current account deficit. In theory, there’s nothing wrong with a rapidly growing economy covering a big deficit in foreign trade with inflows of foreign capital. But in Turkey’s case, two facts give pause. First, Turks save far less of their incomes than their counterparts in rapidly growing Asian economies, making them uncomfortably dependent on foreign investment to cover the costs of growth in productive capacity. Second, much of the capital inflows consist of “hot money” – short-term loans that can exit as fast as they entered – putting the economy at considerable risk in the event of, say, a crisis in which Turkey was sucked into Syria’s civil war.

Then there’s the question of economic justice. The post-2001 high-growth years, in which average real incomes nearly doubled, still left millions of Turks in poverty. The bottom tenth of households take home just two percent of total income, and Turkey ranks among the bottom-three members of the OECD in terms of overall income inequality. The most pressing economic problems, though, are related to macro stability rather than long-term fundamentals. An uptick in inflation could trigger an exodus of hot money and attendant instability in the exchange rate.

In the atmosphere of uncertainty created by turmoil in the region, any sign that the government has set aside price stability as its highest economic priority could undermine investment driving modernization. Indeed, even if the government chooses to err on the side of conservative fiscal and monetary policy, Turkey’s prospects in the short term may be determined by events beyond its control – that is, everything from the euro crisis to the civil war in neighboring Syria to the anti-western dynamic of Arab Spring revolutions.

*Cenk Sidar is the managing director of Sidar Global Advisors (SGA) in Washington DC. This article was originally published in Foreign Policy magazine on Sept. 20, 2012.