Turkey: Risk Assessment
Country Risk Rating
Business Climate Rating
- Young and educated workforce
- Well developed and flexible manufacturing tissue
- Strategic geopolitical location
- Strong economic recovery after COVID-19
- Recovering export performance that reduces current account risks
- Large dependence on external financing
- Import-dependent structure of the manufacturing sector
- High inflationary pressures resulting from the lira’s weakness
- Weakened central bank reserves, higher public debt
- Increased regional and geopolitical tensions
Resilient post-pandemic growth, persisting financing challenges
The Turkish economy recovered by a stronger-than-expected 6.7% year-on-year (YoY) in the third quarter of 2020 after contracting by nearly 10% YoY in the second quarter, as anti-COVID-19 measures hit the economy. The growth was fuelled by large and cheap credit expansion (50% YoY in June), fiscal stimulus (12.8% of GDP in 2020) and recovering external demand thanks to the easing of the lockdown measures. However, the loose monetary and accommodative fiscal policies resulted in a widening of both public and external deficits, as well as a surge in inflation (14% YoY in November 2020 compared to the official target of 5%). Although the central bank adopted a more conventional monetary policy in November by hiking its policy rate by 475 basis points to support the ailing lira, the cumulative depreciation of the latter (around 30% versus USD in 2020) will continue to create an obstacle for reducing inflation. An increase in oil prices on the global markets would add to inflationary pressures, as the Turkish economy remains dependent on energy imports despite the recent gas drilling efforts in the Black Sea and East Mediterranean. Tighter financial conditions and reduced consumer confidence due to high inflation will weigh on household consumption (60% of GDP) growth in 2021. Furthermore, higher interest rates and imported inputs costs will weigh on investments. Conversely, the fiscal stimulus is expected to remain for some time in order to support households and businesses. Nevertheless, a renewed increase in COVID-19 cases in the last quarter of 2020 slowed the recovery in retail and of the economy. Therefore, the developments regarding the vaccine will be important, as it will both affect domestic and external demand.
Lower current account and fiscal deficits after COVID-19
In January-October 2020, the current account recorded a deficit of USD 31 billion, compared to a surplus of USD 9.6 billion in 2019. The deficit is expected to narrow in 2021 on the back of a recovery in tourism revenues (nearly USD 26 billion in 2019, around 3.5% of GDP), which will depend on vaccine-related developments. Additionally, higher exports in 2021, due to the global economic recovery, and slower gold imports (requested by households as a traditional self-protection instrument against inflation), will also contribute to this narrowing. Moreover, the strong depreciation of the lira and subdued internal demand will soften imports overall. Regarding the financing, foreign direct investments (which stood at USD 3 billion in January-October 2020, i.e. below 1% of GDP) and portfolio investments (net outflow of USD 12 billion in January-October 2020) will remain weak due to the higher risk aversion of international investors versus Turkish assets. Depleted reserves, high inflation, lira volatility and sudden changes in regulations represent key challenges for the Turkish economy. The central bank’s gross international reserves (excluding gold) fell to USD 44 billion as of November 2020 compared to USD 78 billion at the beginning of 2020. Excluding banks’ required reserves, net foreign exchange reserves are negative. Moreover, the swap-reliance increased during 2020, as the net short position increased from USD 18.2 billion in end-2019 to USD 61.3 billion as of October 2020. Turkey’s short-term external debt rose to USD 124 billion (nearly 20% of GDP) as of the second quarter of 2020, with 62% owed by companies and banks. Falling reserves and a high level of external debt increase Turkey’s risk premium and borrowing costs. However, the new economic team has returned to policies that are more conventional and the authorities have repeatedly underlined their willingness to implement reforms targeting the improvement of the business environment. Low level of public debt (almost evenly split between domestic and external creditors) gives the government the comfort to maintain the fiscal stimulus during 2021. However, increased interest payments, guarantees provided under the public-private partnership projects and reduced level of tax collection due to slower growth under COVID-19 will weigh on fiscal performance.
Rising geopolitical tensions amid stretched relations with the EU and the U.S
The geopolitical priorities of Turkey and some of its Western allies have started to diverge in the last few years. Turkey’s active policy in its region seems likely to persist in the upcoming period, in line with the country’s national geopolitical stance. Consequently, relations between some European countries and Turkey may remain strained. However, their close economic ties and their willingness to increase trade volumes and reduce their supply chain risks after COVID-19 represent a potential of improvement to their relations. On the other hand, relations with the U.S. under the new president Joe Biden will have to be monitored closely, particularly in terms of sanctions over the S400 missile system.