Erdogan steers into uncharted waters

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Few countries have goals as grand as Turkey’s; few cities have ambitions that compare with Istanbul’s. The dynamism of the Turkish commercial capital is inescapable, as is that of prime minister Recep Tayyip Erdogan, its member of parliament and most ardent champion.

That said, Turkey is going through a challenging time of transition. Both the economic model that has brought it success and Mr Erdogan’s style of government could be tested and, indeed, overturned, by events.

The prospect of tighter US monetary policy has made the international economic environment less forgiving for a country with Turkey’s structural imbalances. Meanwhile, Mr Erdogan’s ambition to become head of state – and his confrontational style – seem set to make next year a political turning point. His own role could markedly change.

In October Mr Erdogan inaugurated the world’s first transcontinental undersea rail tunnel, linking the Asian and European sides of Istanbul. A sign at the entrance to the Marmaray tunnel thanked the “great chief” – the prime minister himself – for pursuing the project, just one of many transforming the city and serving as calling cards for the new Turkey.

The Zorlu centre, a towering new mall, arts, housing and office complex near the financial district proclaims Turkey’s ability to attract international brands and to charge rents of €150 a square metre and more. The country’s young consumers are the great draw.

This is the Turkey that Mr Erdogan is building. In most of the 81 provinces, you can see his ambition taking concrete form. To many eyes, foreign and domestic, it is a world of opportunity, an $800bn economy of 76m people enviably placed between Europe, Asia, Africa and the Middle East.

“If you invest here”, says Selcuk Yorgancioglu, head of Turkey and Central Asia for Abraaj, the Dubai-based private equity group, “you need to be hands on, but when you do that you make money.” Abraaj’s recent high-profile deals include the sale of a 50 per cent stake in Turkey’s largest hospital chain as part of a larger $2bn transaction.

Other recent noteworthy deals include big secondary public offerings of Ulker, a leading biscuits and chocolate producer, and Emlak Konut, a government-controlled property developer. Allianz bought Yapi Kredi Sigorta, the insurer.

“Institutional investors are still betting on growth,” says Cem Karakas, head of finance at Yildiz Holding, Ulker’s parent, particularly that “driven by Turkish consumers”.

At the same time, neither the rates of growth that Turkey has enjoyed during Mr Erdogan’s decade in office, nor the leadership he has provided can be taken for granted in the years ahead. Turkey, like other emerging markets, will still probably outgrow most developed economies and converge towards their standards of living. Yet, if the US Federal Reserve reins in its monetary stimulus, which has helped boost emerging markets, growth is likely to slow.

To an important extent, the change has already occurred. Turkish officials themselves engineered a slowdown from an unsustainable level of about 9 per cent in 2010-11 to just 2.2 per cent last year. Gross domestic product is expected to rise 3-4 per cent this year.

Mr Erdogan’s goal to make Turkey one of the world’s 10 biggest economies by 2023 – which would require growth of some 15 per cent a year – seems well out of reach. In the months since the Fed first broached its policy of reducing, or “tapering”, its monetary stimulus, the Turkish lira has become more vulnerable. This is largely because of fears that the country’s economy is out of balance.

It was bad enough that Turkey ran a current account deficit of about 10 per cent of gross domestic product when the economy was firing on all cylinders.

It is, if anything, of greater concern that the deficit may amount to 7 per cent this year, even with the economy growing more slowly. Particularly worrying is the financing of the deficit – only some 15 per cent is underwritten by foreign direct investment, which remains well below its 2007 peak of $22bn.

In part, this is because of fewer privatisation opportunities and the travails of the EU, traditionally the main investment source.

The rest of the deficit is financed by short-term funds, of the kind that, with Fed tapering, may be much less available.

Turkish ministers argue that tapering will lead to a repricing phenomenon, namely that a weaker lira, among other factors, will still draw in sufficient foreign funds. “We have a large current account deficit but that is the only rough spot in a relatively solid macro picture,” says Mehmet Simsek, finance minister.

He adds that the government is working on structural reforms to attract foreign direct investment: “We need to attract more FDI: that is key to everything, to making this country, more productive, more innovative, but also to avoid hiccups down the road associated with large current account deficits.”

Others argue that Turkey needs a sizeable shift away from consumption and towards exports, perhaps facilitated by further lira devaluation.

The International Monetary Fund warns that, without structural reforms, growth will either remain slower or suffer from “bouts of instability” because of a dependence on “highly volatile external inflows”.

A recent report by Goldman Sachs labelled Turkey’s current account deficit “unsustainable” and foresaw a “potentially very costly” adjustment.

Events this year have displayed Turkey’s political unpredictability. Tempers may have calmed since the Gezi Park demonstrations at the end of spring, when the prime minister accused an “interest rate lobby” of plotting against the country and promised to “throttle” speculators. Memories of that confrontation linger, however.

Koc Holding, Turkey’s biggest company, is still having its tax affairs investigated after it was criticised by Mr Erdogan during Gezi, and the prime minister has a way of angering the middle and professional classes. They recoiled, for example, at his recent suggestion that he would make it illegal for men and women to share private student accommodation.

Some leading Turkish executives privately talk of a climate of fear, adding that the personalisation of power under Mr Erdogan undermines Turkey’s attractiveness for foreign investors. Government ministers retort that the prime minister has carried out unparalleled political and economic reforms.

Next year, Mr Erdogan, who has promised to serve no more terms as premier, is expected to compete in the first direct presidential elections. Victory might allow him to beef up what has been a largely ceremonial post. “Erdogan certainly has a huge fan base, which sees him almost as a faultless ‘master’,” wrote Mustafa Akyol, a leading columnist and once a government supporter. But he went on to add that rifts were growing between centre-right conservatives and Islamists in the ruling AK party because of the prime minister’s “reckless one- man show”.

Posters of Mr Erdogan are almost everywhere but the country may be heading for destinations he has not planned. Amid new economic and political currents, Turkey could find itself in troubled waters.

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