Originally appeared on Bosphorus Consulting on 20 January 2014
While there are still reasons to be positive about Turkey’s economy, Turkish companies will find it increasingly necessary to fine tune their image to weather the currently growing credibility gap, identified by Morgan Stanley as a serious issue in their report of 15 January 2014. As The Financial Times (“Clash of values”, 13 January 2014) points out, the economic successes of the early 2000s are now under threat, but the market is still dynamic and able to attract foreign investment. In this new climate, attracting that investment will mean that Turkish companies must do some recalibrating to bolster their appeal internationally. If done well, the rewards could be great.
As we addressed in Bosphorus Consulting’s blog post on 13 January 2014, Fitch Ratings reported on 7 January 2014 that the ongoing political crisis has brought Turkey’s existing vulnerability to changes in capital flow back into the spotlight. Recent events have reminded us that Turkey’s susceptibility to political risk is still a key systemic weakness. Perceptions of political risk affect investor sentiment considerably. As such, domestic upheavals have a tendency to affect the economy with alarming speed. In June and July of 2013, Turkey experienced a $4 billion outflow of portfolio investment, and according to The Centre for Eastern Studies (“Turkey’s economy: a story of success with an uncertain future”, 6 November 2013) maintaining a positive image among foreign investors is key to reducing the risk of capital flight, which is still very apparent.
The obvious negative impact of such outflows of capital on the economy are exacerbated by the country’s already heavy reliance on foreign investment. Morgan Stanley had previously predicted that there would be a revival of foreign investment into Turkey, following a number of years of decline. This prediction was scrapped, however, following the blow dealt to investor sentiment by current events. Now, no upturn is expected. This decline in foreign investment in Turkey has been underway for a number of years. By August 2013, net direct investment had more than halved that of its peak in 2007 and, even with a slight upturn in 2011, the overall trend has been markedly downwards ever since.
Unfortunately, 2013 was a particularly low year for foreign investment in Turkey. The US Federal Reserve’s tapering, which affected emerging market economies across the board, is certainly partly to blame, but this is by no means the sole reason for the poor performance. As The Financial Times reports (“Turkey uncertainty deters investors”, 27 November 2013), the downturn was already well under way, long before these concerns came to light.
Nonetheless, this tapering has likely worsened an already negative situation. Many Turkish companies had become increasingly reliant on the short-term capital provided by the “hot money” made available by the US Federal Reserve’s quantitative easing, claims the Centre for Eastern Studies. One third of Turkey’s current debt is in short-term debt accounts, and 68% of this is from the banking sector, raising concerns as to Turkish banks’ ability to pay off these debts. In any case, these developments paint a picture of a Turkish economy where companies may have to start re-thinking their approach to working internationally.
Investor sentiment is also negatively affected by foreign exchange, exposing Turkish companies to more vulnerabilities. The Central Bank has been buying up Lira with Dollars to maintain its value, writes The Economist (“The mask is off”, 11 January 2014), as well as using the “reserve-option mechanism” to reduce inflation, an unorthodox alternative to raising interest rates, that the publication claims has unsettled investors. While for the moment, Turkey retains its investment grade credit rating, a number of rating agencies (The Economist) have cautioned that continuing negative performance may eventually lead to a downgrade and others have given increasingly cautious assessments of the economy.
But all is not doom and gloom, and Turkey is still regularly touted as an emergent player. However, foreign interest will likely be more cautious than before. The challenge for Turkish companies now, given the changed circumstances, is how to orientate themselves most effectively and how to profit from these new realities.