Turkey: Risk Assessment
Country Risk Rating
Business Climate Rating
- Demographic vitality
- Large population with rising middle-income class
- Strategic geographic location
- Well-developed industrial base
- High capacity of creating employment
- Domestic and geopolitical instability
- High dependence on external borrowing
- High import reliance of the industry
- Security risks
Solid Growth Buoyed by Fiscal Measures, Domestic Demand, and Exports
Turkey is expected to record strong growth rates in 2018 after experiencing several shocks – such as a failed coup attempt, sharp depreciation of the lira, and security issues – in 2016 and 2017. Growth is set to be stimulated by government support, private consumption, investments, and exports. However, rising inflationary pressures, a weaker lira, and tax hikes are likely to weigh on domestic demand, which in turn may impact domestic-driven sectors’ performances. In early 2017, the government decided to increase the size of the credit guarantee fund (CGF) to ease small and medium companies’ access to financing. The size of the fund has been raised to TRY 250 billion (USD 63 billion, nearly 7% of GDP). Rising capacity utilization and improving business sentiment are expected to sustain private investment, yet the pace of growth may lose some momentum as the impacts of the CGF fade away.
Exports are set to remain strong in 2018 on the back of the steady growth in Western Europe, Turkey’s main trading partner. A continued depreciation of the lira will admittedly help boost exports but remains the main risk for Turkey’s import-dependent economy in the upcoming period. Non-financial private sector’s short-term foreign currency denominated debt stood at USD 44 billion as of the second quarter of 2017. Any additional weakness of the lira will increase the debt burden and the costs of imported inputs for the manufacturing sector. A likely rate hike process from the central bank to counter the currency weakness and inflationary pressures would, on the other hand, add to borrowing costs. This scenario would deteriorate cash flow management of Turkish companies, who suffer from a structural undercapitalization.
Twin Deficits: A Cause for Concern
While promoting banks’ lending, the government’s CGF programme pushed the banking sector’s loan to deposit ratio as high as 125% in the second quarter of 2017. This situation increases currency risks and dulls the rebalancing of the current account deficit. The widening of the budget deficit was related to higher interest expenditures, capital transfers, and current transfers. In total, non-interest expenditures rose by 17.8% year-on-year in the first seven months of 2017, while interest expenditures increased by 11.8%. Further widening of the deficit was prevented by a recovery in revenues.
The higher fiscal deficit also raises the Treasury's borrowing requirements. Between January and September 2017, the Treasury's total Eurobond issuance reached USD 9.1 billion, although the planned annual amount was only USD 6 billion. Domestic debt roll-over ratio of the treasury rose to 154.6% in September 2017 from 90.6% annually in 2016. Off-balance sheet stimulus measures may represent upside risks to debt levels if they are realized, as the government may need to assume liabilities mostly due to the public guarantees given under the Public-Private Partnership (PPP) projects. Although expansionary fiscal policy is likely to be gradually scaled back in 2018, the average fiscal deficits may continue to remain high ahead of the elections in 2019, compared to previous periods. Further deterioration of fiscal dynamics may weigh on investors’ sentiment and interest rates.
The structural lack of savings will likely continue to be the economy’s Achilles heel in 2018. The current account deficit is expected to decrease somewhat on the back of slower GDP growth, but the recent recovery in energy prices will increase the import bill further. Against this backdrop of significant current account deficit, the economy remains dependent on volatile and short-term external financing and continues to be vulnerable to exchange rates’ volatility and exit strategies of major central banks. Indeed, FDI – still deterred by regional geopolitical tensions – are not significant enough to offset the current account deficit.
Lower Political Noise, Rising Geopolitical Tensions
Following the April 2017 referendum regarding a vote on constitutional amendments that would transform the country from a parliamentary democracy into a presidential system, political noise has eased in Turkey. Additionally, improving relations with Russia, Iran, and Iraq’s central government have allowed the country to strengthen its regional cooperation and commercial flows. However, the uncertain relationship between Turkey and the European Union, as well as recent tensions with the United States, should be monitored closely, as they may have economic impacts if tensions rise. Turkey has planned three elections for the near future, with the first – local elections – set to take place in March 2019. If domestic political tensions increase ahead of this, then the economy may be negatively impacted, as it would increase risk aversion against Turkish assets.