78324167 country outlook turkey

7/29/2019 78324167 Country Outlook Turkey

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Created on 02 Aug 2012 Page 1 of 26

Country Intelligence: Report

Turkey REPORT PRINTED ON 02 AUGUST 2012


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This information was last updated on 20 JUL 2012, 1:20 PM EDT (17:20 GMT)

Outlook and Assumptions: Outlook

While the central bank's monetary policy is reducing the current-account deficit, risks to stability remain

substantial. After more than a year of unorthodox and controversial monetary policy, the Central Bank of the

Republic of Turkey (CBRT) finally began to see success in reducing external imbalances as 2011 came to a closeand through the first five months of 2012. The ongoing success of the monetary policy, including a recent

deceleration of inflation, suggests the CBRT will not deviate from its position in the near future. Even with the

current-account deficit narrowing rapidly, the overall gap remains dangerously large, keeping Turkey vulnerable to a

financing crisis should investor sentiment turn sour on the back of a major event such as the Greek exit from the

Eurozone. Although the lira is now stronger, defending the Turkish currency earlier in 2012 depleted reserves,

making the country even more vulnerable to a potential financing crisis.

The Turkish economy has come in for a soft landing, with growth momentum strong compared with the rest

of Europe. After surprisingly strong expansion in the first quarter of 2012, some deceleration may be noted in the

second, but according to leading indicators, growth should remain relatively robust in relation to the rest of Europe.

In the second half, with interest rates potentially easing somewhat at home, growth could pick up once again.

Although overall expansion for 2012 as a whole will be slow in comparison to recent years, it will almost certainly be

one of the top rates of expansion across Turkey. Export gains to Iraq and the rest of the Middle East will continue to

fuel the expansion. The recent passage of a new incentive scheme to help buoy intermediate good producers will

help to boost investment expenditures in the short term, further buoying overall GDP growth. The CBRT will be

careful to not allow domestic demand to grow too rapidly, however, for fear of undermining the continued progress

on narrowing the current-account deficit.

Sustained strong fiscal spending remains a concern, however. In its effort to facilitate its economic recovery, the

government has maintained a high level of spending, a position from which it is only slowly moving. Even with its

spending still strong, the government budget balance narrowed sharply in 2011, primarily owing to soaring revenues

coming from a rapidly expanding tax base. This surge of tax revenues allowed the government to avoid potentially

painful spending cuts in an election year. So far in 2012, the government has allowed spending to continue to surge,

a position that it must reverse moving forward to help alleviate the demands on needed financing. Given the

uncertainty in the Eurozone situation and the potential negative contagion, it is more critical than ever that the

government demonstrate a clear commitment to greater fiscal austerity in order to mitigate potential investors

worries.

Outlook and Assumptions: Domestic Assumptions

The Central Bank of the Republic of Turkey (CBRT) maintains its current monetary policy as the current-account

deficit continues to narrow. The gap remains dangerously large in 2012 and 2013, but adequate financing for the

shortfall is found.

The ongoing crisis in the Eurozone does not substantially turn investor sentiment away from Turkey. With its public

debt and overall external debt well within manageable ranges and its financial system is in many ways more stable

than many of those in Europe, Turkey avoids a strong contagion effect of the ongoing problems in Europe.

The Justice and Development Party (AK) increase their control over the government and the economy, but do not

overstep their bounds in the foreseeable future. Already, the central bank governor is thought to have close ties to

the government, resulting in its more pro-growth stance. In spite of the blurring of the separate powers, the

government does not abuse its position too much and maintains defensible policies.


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Unrest from radical Kurdish groups does not negatively affect the economy as a whole.

Outlook and Assumptions: Alternative Scenarios

The Eurozone crisis intensifies further, providing a greater challenge and financial drain on the region as a whole,

eventually overwhelming the Turks' relatively healthy financial indicators, pushing the country into a debt crisis.

Already, the country is facing too-rapid expansion of credit and heavy external financing demands. An evaporation of

capital inflows in the wake of the Eurozone debt crisis could jeopardize stability in the country.

The Justice and Development Party (AK) push through a much more aggressive centralization of power than

currently anticipated. While the AK Party does not have a Constitutional majority, it nonetheless has great political

power in the country. Its biggest detractors worry that it will ultimately undo much of the secular nature of the state

while at the same time centralizing greater power in the leadership. Should politics develop this way, some

free-market mechanisms could be threatened.

Turkeys EU accession bid is suspended, either by Brussels or by Ankara. If either side breaks off negotiations

completely, the Turkish economy could destabilize, although we believe this disruption would be limited. Turkey

would become more intimately involved with the countries of the Middle East and, more broadly, the Muslim world.

Widespread terrorist attacks spread throughout the country following the PKK's ending of its cease-fire, severely

jeopardizing vital tourism revenues and inflows of foreign capital.

Economic Growth: Outlook

Although growth may further decelerate from its first-quarter level, the Turkish economy has likely come in for a

relatively soft landing. In the second quarter, GDP expansion could be slower than was noted in the first quarter,

according to leading indicators, but as compared with the rest of Europe, growth will remain as one of the stronger rates

noted for that time. Growth momentum has been maintained by substituting European demand with increased exports to

Iraq and the Middle East. Domestic demand was relatively depressed in the first quarter and will likely be slow to recover

as the central bank has not been overly eager to loosen monetary policy. Nonetheless, with favorable current-accountnumbers being noted through the first half of the year, some easing of monetary policy in the second half can be expected,

which should help to buoy domestic demand. Overall, we anticipate GDP will growth around 3% for 2012 as a whole.

While this rate of growth will be quite slow compared with the booming recovery noted in 2010 and 2011, it will

nonetheless be one of the strongest rates of growth noted throughout all of Europe.


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In the medium term, annual growth rates will remain elevated vis--vis the rest of Europe, although annual gains will

remain much lower than they were in both the 200207 stretch and again in 201011. Rates were restrained by structural

damage to the economy from the 200809 crisis and the current sovereign risk threats, but also because of the need to

deleverage public debt, which will add a headwind through the medium term. In particular, continued European problems

are constraining growth projections for 201314, although growth of around 4% will be quite substantial compared with the

rest of Europe. Thereafter, assuming Europe begins to grow again, growth should push closer to 5% annually for Turkey

throughout the medium term as exports receive a boost and investment activity improves.

Economic Growth Indicators

2009 2010 2011 2012 2013 2014 2015 2016

Real GDP (% change) -4.8 9.2 8.5 2.9 4.2 4.1 5.0 5.3

Real Consumer Spending (% change) -2.0 5.9 7.2 1.6 4.1 3.5 4.2 4.6

Real Government Consumption (% change) 7.8 2.0 4.5 2.2 2.3 3.1 3.3 3.6

Real Fixed Capital Formation (% change) -19.0 30.5 18.3 3.3 5.9 5.4 5.0 5.6

Real Exports of Goods and Services (%

change)-5.0 3.4 6.5 7.6 4.0 4.9 5.0 4.7

Real Imports of Goods and Services (%

change)-14.3 20.7 10.6 -0.8 4.8 4.8 4.2 4.3

Nominal GDP (US$ bil.) 614.6 731.1 773.1 802.2 806.1 945.6 1,103.7 1,238.6

Nominal GDP Per Capita (US$) 8,554 10,050 10,498 10,766 10,697 12,411 14,333 15,921

Source: Historical data from selected national and international data sources. All forecasts provided by IHS Global Insight. Table updated on the

15th of each month from monthly forecast update bank (GIIF). Written analysis may include references to data made available after the releaseof the GIIF bank.

Download this table in Microsoft Excel format


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Economic Growth: Recent Developments

The Turkish economy managed to grow relatively strongly in the first quarter of 2012. In JanuaryMarch 2012, GDP

expanded 3.2% year-on-year (y/y). Although growth was the slowest it had been since the country exited its 200809

recession, it nonetheless surprised observers on the upside, far outstripping growth rates noted across most of the rest of

Europe. Sustained, strong export gains were the primary engine for overall economic expansion. Strong gains in

shipments to Iraq and the rest of the Middle East more than offset the loss of European demand, allowing the exports ofgoods and services to grow 13.2% y/y, the strongest such gain since 2007. Meanwhile, imports of goods and services fell

5.0% y/y in the first quarter, driven downward by the continued dampening of domestic demand by the Central Bank of the

Republic of Turkey (CBRT). Tight monetary policy kept household consumption from growing much at all (up just 0.3% y/y

in the first quarter) and depressed gross fixed capital investment expansion as well (up just 1.6% y/y).

Although growth decelerated in each successive quarter, GDP expansion remained vigorous in 2011 as a whole.

After soaring by 11.9% y/y in the first quarter, GDP growth slowed to 9.1% y/y in the second, 8.4% y/y in the third, and

5.2% y/y in the fourth quarters, respectively. Overall for 2011, however, GDP expansion remained strong at 8.5%.

Domestic demand propelled the economy forward in 2011. In particular, gross fixed capital formation soared by 18.3%,

vigorous credit expansion propelling ahead growth. Expansion in fixed capital investment did decelerate sharply as the

year advanced, however, with growth tumbling from 33.9% y/y in the first quarter to only 2.4% y/y in the fourth quarter.

Similarly, household consumption growth also decelerated as the year progressed, with the improvement dropping from

11.4% y/y in the first quarter to a mere 3.2% y/y in the fourth. For 2011 overall, though, household consumption grew by

7.2%. Meanwhile, the Turkish economy managed to keep its exports growing rapidly. Although base effects sharply

reduced growth in the second quarter, exports managed to expand by 6.5% for the year as a whole, inclusive of a

6.7%-y/y expansion in the fourth quarter as a whole. However, net exports were a strong contributor to growth even as

export growth slowed in the second half of the year because import growth slowed even more sharply. After soaring by

22.6% y/y in the first half, imports of goods and services edged up just 0.6% y/y in the second half of the year.

Real GDP Changes

2010 2011

GDP 9.2 8.5

Household Consumption 5.9 7.2

Government Consumption 2.0 4.5

Fixed Capital Investment 30.5 18.3

Exports of Goods and Services 3.4 6.5

Imports of Goods and Services 20.7 10.6

Source: Turkish Statistical Institute

The economic recovery in 2010 was the strongest in Europe. In 2010, GDP soared 9.2%, more than recovering what

had been lost due to the global economic crisis in 200809. With the 2010 recovery surpassing the 2009 downturn, the

economy was the largest it has ever been, both in real and nominal terms. As in 2011, the economic recovery in 2010 was

domestically driven. The Turkish banking and financial system survived the 200809 crisis in much better shape than

many of its counterparts in Europe, thus allowing for a vigorous expansion of credit. This strong revival bolstered both

household consumption and fixed capital formation. Strong domestic demand, however, did have a negative knockdown

effect on the economy, as imports grew much more rapidly than did exports, leading to a negative contribution of net

exports on headline GDP.


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Economic Growth: Consumer Demand - Outlook

Consumer confidence will resume a slow climb, although strong headwinds will continue to temper the potential

gains. Although consumer confidence is still around four-year highs, the anticipated deterioration of confidence occurred

in the second quarter due to tightening credit conditions, high inflation, and increasing worries about contagion from the

likely Greek exit. In particular, worries that the banking system may have expanded credit too rapidly in the past few years

may result in a much more conservative future of credit. Looking forward, confidence is likely to face periodic losses; in

particular, should the recent improvement of labor markets stall because of a slowdown of industrial production.

Nevertheless, it should resume an upward trend, even if it does not quite reach the 100-point demarcation line in the near

future. Historically, Turkish consumers continue to spend even in the face of strong headwinds. The Turkish population is

large and young, and remains relatively underserved by banking practices and credit. The market is seen as having great

potential for retailers in the longer term because of these favorable demographics. However, in the short and medium

term, the outlook for consumer demand remains guarded.

Economic Growth: Consumer Demand - Recent Developments

Consumer confidence remained weak in the second quarter of 2012, down from prior quarter. After averaging 93.1

in the first quarter of 2012, the consumer confidence index averaged just 91.7 in the second quarter, well below its

year-earlier levels. Rising problems with inflation, concerns of tightening lending conditions, and the worsening of the

Eurozone crisis raging just outside of Turkeys borders contributed to the second-quarter deterioration. Even after the

second-quarter correction, however, the index remains well above its level throughout most of 2007 through 2010. The

global economic crisis sent this index tumbling to a historical nadir of 68.9 as of November 2008. Aggressive interest-rate

cuts by the Central Bank of the Republic of Turkey (CBRT) from late 2008 through late 2009 and expansionary fiscal

policy aimed at reviving consumer borrowing helped to slowly build the index back up from late 2008 through late 2009.

After a period of some slippage toward the end of 2009 due to growing worries regarding labor markets, the index was


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again generally strong in 2010. In 2011, the index reached a recent peak in June, at 96.4, the highest it had been in four

years. It deteriorated throughout the bulk of the second half of the year before finally turning back upwards in the fourth

quarter of the year and spilling over into early 2012.

Stronger consumer confidence has paralleled the revival of household consumption activity. At the peak of the

global crisis, Turkish household consumption was plunging by double digits. The CBRT's aggressive actions to restore

consumer confidence, however, and the general strength of the Turkish financial sector helped limit the period during

which Turkish consumer activity contracted. As a result, as early as fourth-quarter 2009, household consumption was

reviving strongly, up by nearly 5% year-on-year (y/y). In 2010, with domestic credit expanding rapidly, household

consumption also continued to grow, up by 6.0% for the year as a whole. By the first quarter of 2011, the strength of therecovery of household consumption was actually becoming a concern, up 12.0% y/y, raising worries of overheating. CBRT

actions to temper domestic demand decreased growth, eventually to only 3.2% y/y as of the fourth quarter of 2011 and

even further, to just 0.3% y/y in the first quarter of 2012.

Economic Growth: Capital Investment - Outlook

The vigorous gains in capital investment noted through mid-2011 will not be re-attained in the near future. Efforts

to contain a gaping current-account deficit, troubles brewing in the banking sector, and the potential contagion from the

Greek exit from the Eurozone all suggest that capital investment activity in Turkey will grow much more tepidly in 2012 and

2013 than it has in recent years. Growth rates similar to what was noted in the fourth quarter of 2011 and the first quarter

of 2012 will be more the norm. A loss of export demand will drive up the amount of idle productive capacity, undermining

the needs for capital improvement. In the longer term, however, capital investment prospects will remain relatively strong.

A large, educated, young population with low labor costsas compared with the EUa central geopolitical location, and a

cooperative government intent on expanding infrastructure development and attracting foreign investors would all provide

a strong impetus for investment activity once the macroeconomic position of Europe returns to more normal conditions.

The country is still in need of significant capital improvement, particularly its infrastructure. Once investment conditions

improve internationally, the country should once again enjoy a strong increase in investment activity.

Economic Growth: Capital Investment - Recent Developments

The vigorous recovery of capital investment has given way to more modest gains in the face of the central banks

tight monetary policy. In 2010, gross fixed capital formation was in the midst of particularly strong recovery, growing

29.9%. In the first nine months of 2011, it grew even more vigorously, up 25.4% year-on-year (y/y). With strong domestic

demand fueling a rapid deterioration of the current-account deficit, the Central Bank of the Republic of Turkey (CBRT) took

more aggressive actions to try to correct the imbalances. As a result, both household consumption and gross fixed capital

formation began to decelerate sharply in the latter portion of 2011. In the final quarter, gross fixed capital formation

managed to grow, but only by 2.4% y/y. In the first quarter of 2012, growth was even weaker at just 1.6% y/y. Despite an

abundance of idle manufacturing capacity in the manufacturing sector as a whole, the private sector utilized extremely lowinterest rates and abundant credit to finance sharp increases in the stocks of their machinery and equipment and undergo

long overdue modernization and streamlining. The tightening of credit conditions towards the end of 2011 and into 2012

helped to stem the strong increases. The public sector, constrained by a need to trim the fiscal gap, has been increasing

investment with more restraint.

This revival of capital investment began from a low base. In 2009, fixed capital formation collapsed, plunging 19.0% for the

year as a whole. Higher costs of borrowing and a surge in idle capacity triggered the drop. The 2009 downturn built on a


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6.2% contraction already recorded in 2008. The downturn in 200809, triggered primarily by the shock of the global

economic downturn, was an anomaly to recent trends. From 2002 through 2006, fixed capital formation grew by double

digits annually, before finally slowing in 2007, when a peak of domestic political uncertainty and elevated interest rates

curtailed further gains. Investment growth had actually been accelerating once again in 2008 before the onset of the global

economic recession. However, by the end of 2010, investment had regained what had been lost, and any further

expansion in 2011 represented new capital investment highs.

Labor Markets: Outlook

With the Turkish economy growing more slowly in 2012 and 2013, the recent strong recovery in the labor market

is expected to backslide somewhat in the near future. While the country's industrial recovery is helping to return many

previously laid-off workers to their jobs, hiring is somewhat guarded as uncertainty regarding future conditions remain

strong. Having laid off thousands of workers from late 2008 through early 2010, Turkish manufacturers are attempting to

boost their productivity levels and guard against future economic downturns by re-hiring workers slower than they

dismissed them. With another economic slowdown in the offing, this reticence in re-hiring will intensify further in the near

future. Nevertheless, we do not expect a major worsening, but rather more of a flattening of employment growth. As such,

the downward push of unemployment should cool in the second quarter of 2012 and beyond before once again pushing

downward in subsequent years. Nevertheless, the improvement in the longer term will be slow, not returning jobless ratesto pre-crisis levels until around 2016 or so.

In the longer term, the greatest challenge for the Turkish labor market will be creating enough jobs to deal with an

expectedly sharp rise in labor participation. Although the official unemployment rate in Turkey is similar to the rates

noted throughout the rest of Europe, its labor-force participation rate is significantly lower. According to a World Bank

study, job creation going forward will be limited by the current large employment in the agricultural sector and unusually

stringent labor regulations. The first of these problems is relatively unavoidable. In its economic development, Turkey will

shed agricultural jobs and add industrial and service jobs. On the latter point, the World Bank urged sweeping reforms to

address high severance packages, limitations on temporary work, and high social security costs. The country must also

combat its pervasive shadow economy, against which potential legitimate employers must compete. Finally, with female

labor-force participation far below the European average, enough jobs must be created as the government pushes to

increase participationfrom 26% in 2009 to 35% in 2023, according to the June 2010 National Employment Strategy.

Labor Markets: Recent Developments

The vigorous economic recovery undid much of the damage done to employment markets by the 2009 downturn.

Even as economic growth slowed, past strong gains continued to drive unemployment down in the first quarter of 2012.

The officially registered jobless rate stood at 10.4% in JanuaryMarch 2012, down from 11.5% a year earlier. In 2011 as a

whole, this same rate had averaged 9.8%, 2.1 percentage points down from its 2010 level. The average annual jobless

rate was the lowest it had been since 2001. Total employment increased by 6.7% over the course of the year, driving thenumber of those out of work downward by 14.2%. Total labor force participation improved from 48.2% in 2010 to 49.1% in

2011. When combined with surveys suggesting why people were out of the labor force, it seems the gray economy was

reduced in 2011. When measured using EU standardized methodology, the jobless rate was even lower than the officially

reported data, suggesting an unemployment rate of only 8.8% for 2011 as a whole. While the addition of jobs and

reduction of unemployment did deteriorate slightly in the fourth quarter of 2011, it did so only modestly.


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Labor-force participation remains below the EU average, particularly among women, of whom less than

one-quarter are employed outside of the house. Unemployment rates would be significantly higher than currently noted

if labor-force participation was at the EU levelthose that are now out of the labor force would instead be listed as

officially unemployed. According to a 2010 National Employment Strategy, an emphasis through the medium term is being

placed upon an increase of women in the workforce, although as 2012 began, little progress was yet noted. As that

participation rate increases with more women entering the labor force, pressure might build for emigration to the EU if job

creation is not significantly accelerated in Turkey.

Inflation: Outlook

Monetary policy is working more effectively than we had anticipated, although we believe a further deceleration

will be difficult. The lowering of global energy price forecasts has helped to reduce the upward pressure on Turkish

inflation in the near term, but we believe that low interest rates will fuel greater domestic demand, undermining the

countrys ability to further reduce annual inflation rates. Additionally, potentially new hikes to excise duties will further

confound efforts to drive annual inflation rates down further. In the third quarter of 2012, annual inflation is projected to

remain in the high single digits. By the fourth quarter, in large part because of favorable base effects, annual inflation could

come down much more rapidly, likely reaching or even surpassing the central banks end-year inflation forecast of 6.5%.

The central bank, in fact, has indicated it would downwardly revise this figure soon, potentially to around IHS Global

Insights own end-year forecast of 5.7%. Despite the drop-off of inflation at the end of the year, annual average consumer

price inflation will remain up from 2011, thanks to strong expansion in the first part of the year. In 2013, annual inflation

could trend upwards as domestic demand returns.

Inflation Indicators

2009 2010 2011 2012 2013 2014 2015 2016

Consumer Price Index (% change) 6.3 8.6 6.5 8.8 6.5 5.7 4.9 4.5

Wholesale-Producer Price Index (% change) 1.2 8.5 11.1 6.6 6.3 6.4 5.5 4.7


15th of each month from monthly forecast update bank (GIIF). Written analysis may include references to data made available after the release

of the GIIF bank.



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Inflation: Recent Developments

Inflation is decelerating, yet remains elevated in 2012 vis--vis 2011 levels. The restrictive monetary policy of the

Central Bank of the Republic of Turkey (CBRT) has found success in finally driving down elevated annual inflation rates. In

June 2012, annual consumer price growth was down to 8.9%. Although still elevated as compared with the 6.2% rate

noted as of the same time in 2011, it nonetheless represents a sharp cooling from two months earlier when the inflation

rate had topped 11%. Throughout the first three quarters of 2011, annual inflation had been at historical lows of between

4% and 6% for the country. Over the final quarter of last year, however, annual inflation accelerated, eventually ending

2011 at 10.4%, far surpassing the 5.5% end-year CBRT target. Elevated global energy prices, uncertainty over the

CBRTs flexible monetary policy, and stronger domestic demand all contributed to the run-up of inflation late in 2011. In

2012, however, the energy price outlook has come down, and the CBRTs monetary policy has gained some comfort,

allowing inflation to trend downward.

After reaching a plateau in late 2011, annual producer price inflation is weaker. From April 2011 to late in the year,

annual producer price inflation steadily accelerated. The negative external shocks on prices at the beginning of 2011 hada direct effect on producer price inflation. Specifically, annual producer price growth jumped from 8.9% as of end-2010 to

10.9% as of February 2011. After easing slightly in subsequent months, inflation began its steady march upward in April,

reaching to 13.7% as of November. Since that milestone, inflation has generally eased, standing at 6.4% as of June 2012.

Exchange Rates: Outlook

We anticipate that the Turkish lira will continue to remain relatively strong vis--vis the US dollar in 2012. Any

nominal depreciation will be modest and represent a relative stability or even strengthening in the real effective exchange

rate. However, the regional concerns regarding the Eurozone crisis will cause some lira losses, even as the countrys own

sovereign risks slowly improve (mainly because of the narrowing of the current-account deficit). With the success of the


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central banks monetary policy, there will be no shift to a more orthodox policy. The continued improvement of the

current-account deficit will help to buoy the lira nonetheless.

In the longer term, the lira will be stable and strong. Assuming that the CBRT and the government succeed in taming

domestic demand and eventually begin to reduce the countrys external obligations, we anticipate that the Turkish lira will

once again resume gaining value in the longer term. Previous worries that the lira might be overvalued have been

dissipated due to the sharp losses noted since 2008. Gains in productivity from increasing capital inflows and the general

push towards greater EU integration should bolster the strength of the lira.

Exchange Rate Indicators

2009 2010 2011 2012 2013 2014 2015 2016

Exchange Rate (LCU/US$, end of period) 1.49 1.54 1.91 1.82 2.00 1.77 1.72 1.70

Exchange Rate (LCU/US$, period avg) 1.55 1.50 1.67 1.80 1.97 1.85 1.75 1.71

Exchange Rate (LCU/Euro, end of period) 2.15 2.06 2.47 2.28 2.30 2.32 2.36 2.43

Exchange Rate (LCU/Euro, period avg) 2.15 1.99 2.33 2.30 2.30 2.31 2.34 2.39



of the GIIF bank.


Exchange Rates: Recent Developments

With the success of monetary policy, the Turkish lira has found stability and remains stronger than it had been at

the beginning of the year. As 2012 opened, the Central Bank of the Republic of Turkey (CBRT) was in the midst of a

strong defense of its currency. In December 2011, worries had mounted that the CBRTs policy mix had not done enough

to stem domestic demand and begin to correct the countrys growing external imbalances, compromising the liras stability.


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By 30 December 2011, the Turkish lira had dipped to a historical low, falling below 1.911 per US dollar. This fall triggered

an aggressive reaction from the CBRT, which flooded the foreign-exchange market with more than USD3 billion of dollar

sales in the final trading day of 2011 and another USD650 million of sales in the first trading day of 2012. In all, this helped

push the lira back to 1.881 per US dollar at the close of 3 January. In the month and one-half that followed, the lira

continued to steadily rally, so by late February, the lira was up to 1.738 per US dollar. Since then, the lira has been

generally strong in spite of some temporary setbacks, showing particular resiliency in recent weeks and months as the

CBRTs monetary policy has begun to find more and more success in reducing the current-account deficit. By mid-July,

the lira was trading at 1.806 per US dollar, 5.5% stronger in nominal terms than it had been at the close of 2011. The

turn-of-the-year defense drew down official reserve levels, but since that initial foray, the bank has had to be less active,

stemming the sharp drawdown.

The lira was generally weaker in the latter portion of 2011. At the outset of 2011, the CBRT had intended to weaken

the currency by pushing interest rates downward to reduce the inflow of foreign capital. By the end of the first half, the lira

exchange rate was down to TRY2.350/EUR1.000, nearly 20% weaker than when the CBRT initiated its policy in

December 2010. In the second half, however, the lira depreciated more rapidly than the CBRT would like because of

mounting worries of overheating and the CBRTs poor policy responses to those concerns. In general, from July until the

meltdown in late December, the lira went through periods of sharp depreciation followed by a stabilizing of the exchange

rate in response to CBRT actions.

Economic Policy: Monetary Policy and Outlook

The Central Bank of the Republic of Turkey (CBRT) is unlikely to waver from its current, unorthodox monetary

policy in the foreseeable future. The most likely interest-rate move sometime in 2012 will be a further reduction in the

interest-rate spread for overnight lending/borrowing, given its success in reducing the current-account deficit and inflation,

in hopes of discouraging too much of an influx of hot portfolio capital. Specifically, the top rate will almost certainly come

down from 11.5% sometime in the next few months. Along with a slight expansionary effect of the lower rate, reducing the

spread would also alleviate some day-to-day uncertainty in what interest rates might be in use. Nevertheless, there is little

indication that the bank will abandon its approach altogether, and the headline policy rate will almost certainly remain

unchanged for several more months. With the continued success of both reducing external imbalances as well as inflation,

it is becoming less likely that the CBRT will need to revert to a more orthodox approach to monetary policy, instead likely

standing by its current monetary policy throughout the remainder of 2012 and into 2013. For now, the biggest failure of the

current approach is sticky inflation, an outcome that the CBRT may be willing to live with given the success in reducing


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external imbalances and the fact that at least inflation is now in high single digits instead of low double digits. The CBRT

would only acquiesce to a shift away from the current approach if the countrys financial markets and foreign investment

inflows are indeed eventually threatened by shifting sentiment.

Monetary Policy Indicators

2009 2010 2011 2012 2013 2014 2015 2016

Policy Interest Rate (%, end of period) 6.50 6.50 5.75 5.75 5.75 5.50 4.75 5.25

Short-term Interest Rate (%, end of period) 17.65 15.27 14.22 15.40 13.41 11.01 9.17 8.00

Long-term Interest Rate (%, end of period) 17.20 14.99 14.19 15.50 14.43 13.08 11.86 9.30



of the GIIF bank.


Economic Policy: Monetary Policy - Recent Developments

The Central Bank of the Republic of Turkey (CBRT) is currently in a cautionary monetary position, while still

maintaining flexibility in its approach. The hallmark of the current approach to monetary policy has been a shift in

interest-rate policy from reliance upon its main policy rate to the overnight interest-rate corridor between lending and

borrowing rates. The CBRT has left its main policy rate unchanged at 5.75% since August 2011. We do not anticipate any

change to this policy rate in the near future. The CBRT currently is putting more emphasis on the spread between the

overnight lending and borrowing rates. At its 21 February 2012 meeting, the CBRT reduced the top of this spread (the

overnight lending rate) from 12.5% to 11.5%, while the bottom of the spread (the overnight borrowing rate) remained at

5.0%. The CBRT is allowing interest rates to fluctuate within this corridor in order to try to achieve exchange-rate stability.

Depending on demand for the lira, the CBRT releases funds somewhere either towards the top or bottom of this corridor.


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Normal days see the CBRT releasing funds at the countrys main policy rate. Exceptional days have the CBRT

releasing funds at a rate of around 11%. The CBRT also regularly changes the value of its repo auctions to also attempt to

stabilize the currency. Unfortunately by pursuing this strategy, interest-rate planning is sacrificed, a negative impact on

potential investors in the country. This policy approach previously garnered criticism for not being effective enough in

addressing the countrys massive external deficits, although in more recent months, much of that critique has been

counteracted by the surprising success in driving down the current-account imbalance and a downward drift of inflation.

More emboldened than ever, the CBRT shows little signs of retreat from its current position and held all policy rates

unchanged at its July meeting. The Monetary Council even began showing signs of relaxing monetary policy somewhat,

although it remains restrictive overall.

Although perhaps equally controversial, the CBRT's policy position is nonetheless evolving from its approach in

the first half of 2011. Beginning late in 2010, the CBRT launched a policy mix of low interest rates and tighter reserve

requirement rates (and other administrative measures). The CBRT had hoped that by maintaining low interest rates, the

influx of "hot" portfolio investment that had previously driven great financial sector instability would be limited. These

inflows had also boosted the Turkish lira, limiting Turkish export competitiveness and boosting import demand. Meanwhile,

to counter the expansionary nature of low interest rates, tighter restrictions on lira holdings would help drain the domestic

economy of excess liquidity, encouraging a sharp slowdown of credit and monetary growth. Through the first half of 2011,

the policy mix had little impact on credit growth or stemming the rapid deterioration of the current-account deficit. In the

third quarter, however, progress was noted. The annual rate of growth of domestic credit, persistently running at around

35% through the first half of the year, finally dropped below the CBRT's unofficial 25% target in September, where it has

remained below since. Meanwhile, the deterioration of the current account eased significantly in the third and fourth

quarters, just as the CBRT had anticipated.

Economic Policy: Fiscal Policy and Outlook

While the governments 2012 budget plan is relatively strict, markets may force the government to eventually cut

spending more substantially. As adopted, the government budget deficit is planned to be TRY21.1 billion for 2012 as a

whole, or what IHS Global Insight estimates would be around 1.5% of GDP. In line with a fairly small fiscal deficit, Finance

Minister Mehmet Simsek stated that public debt could ease from 39.8% of GDP in 2011 to 37.0% of GDP in 2012.

However, the 2012 budget as adopted may be significantly altered before the end of the year. Growth will likely disappoint

as compared to the budgets assumption, undermining potential revenue gains. Moreover, there remains an unwillingness

by the government to significantly cut spendingas demonstrated by the continued sharp rise of expenditures through


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May 2012relying instead on increasing revenues. In fact, the government plans to increase state employment by 90,000

in an effort to ward off the potential deterioration of the labor markets as the negative ramifications of the Eurozone debt

crisis hits Turkey. A more substantial effort to cut spending would help calm markets that remain jittery over the countrys

dangerously large external imbalances. However, we expect that even with the fiscal problems, the countrys primary

budget balance will remain firmly in surplus in 2012, with interest spending estimated to be around TRY50 billion.

Economic Policy: Fiscal Situation - Recent Developments

The leading, cash-budget indicators show that the government continues to allow spending to rise quickly.

Through the first five months of the year, these cash-budget data indicate a 16.3% year-on-year (y/y) increase in

non-interest expenditures. Even with the still-strong gain in spending, the overall primary budget balance improved y/y in

JanuaryMay 2012, to 20.221 billion lira (up from TRY16.166 billion in the same period of 2011). Although economic

growth is presumed to have slowed in the first quarter of 2012, budgetary revenues nonetheless grew rapidly in

JanuaryMay 2012, up 17.6% y/y.

The booming economy pushed Turkeys consolidated budget deficit downward to 1.3% of GDP in 2011, a

five-year low and easily besting the 2.8%-of-GDP target. Budgetary revenues boomed due to the strong economy,

rising by 16.3% on the back of a 20.5% surge in tax revenues. Meanwhile, expenditures grew much more modestly, up

6.4%, allowing for the sharp improvement in the headline fiscal balance. Although the government did keep spending from

growing too rapidly, the slow gain in overall expenditures was much more a reflection of lower interest paymentsdown

12.6%than any excessive austerity measures by the government. Non-interest expenditures still grew 10.1%. Thus, the

overall primary balance did not improve as dramatically as the consolidated headline figure did. Nevertheless, the country

posted a primary surplus of 1.7% of GDP for 2011 as a whole.

After a disastrous 2009, the Turkish government re-tightened fiscal policy in 2010. In 2010, Turkey posted a

consolidated budget deficit equivalent to 3.6% of GDP. The shortfall represented a sharp correction as compared with

2009, when the government ran a shortfall of 5.5% of GDP. In addition, for 2010 as a whole, the fiscal deficit came in

below the government's earlier projection of TRY44 billion, or 4% of GDP. The critical primary budget balancethe overall

budget balance minus interest expendituresfor 2010 was in surplus by TRY6.215 billion, a positive turnaround from the

TRY4.371-billion shortfall posted in 2009. The country's fiscal state was aided by a strong surge in tax revenues, the resultof the strong domestic demand recovery. Further contributing to the sharp improvement in the state's finances, the

government also successfully limited spending increases, and interest expenditures were alleviated by falling rates.

External Sector: Outlook

For 2012, we project that the current-account deficit will dip close to 8.0% of GDP for the year as a whole. While

that gap still represents a major risk to continued stability in the country, it nonetheless represents a significant

improvement against the 2011 level. The improvement of the current-account deficit in the final months of 2011 and early

2012 was much more substantial than we had previously anticipated. This sharp narrowing of the current-account deficit

gives some hope that the overall deficit may be substantially reduced in 2012, at least as a share of GDP. The Central

Bank of the Republic of Turkey (CBRT) is seemingly choosing to address the current-account deficit as its top priority

rather than battling inflation, although the latter has even begun to drift downward. With global energy prices now forecast

to be lower than previously expected, further strong gains in the current account can be expected over the remainder of

2012. Some improvement will be moderated as the CBRT will likely ease monetary policy at home, preventing the current

fall of imports to continue unabated. Even with the strong improvement in the current-account deficit, the gap remains


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large enough to put immense strain on the countrys ability to find financing given the risk aversion that remains strong in

the shadow of the Eurozone debt crisis.

Trade and External Accounts Indicators

2009 2010 2011 2012 2013 2014 2015 2016

Exports of Goods (US$ bil.) 109.6 120.9 143.5 157.1 168.3 179.8 191.7 204.3

Imports of Goods (US$ bil.) 134.5 177.3 232.9 237.5 251.2 266.2 280.2 294.9

Trade Balance (US$ bil.) -24.8 -56.4 -89.4 -80.5 -82.9 -86.4 -88.5 -90.6

Trade Balance (% of GDP) -4.0 -7.7 -11.6 -10.0 -10.3 -9.1 -8.0 -7.3

Current Account Balance (US$ bil.) -13.4 -46.6 -77.2 -66.6 -66.0 -68.2 -68.9 -73.8

Current Account Balance (% of GDP) -2.2 -6.4 -10.0 -8.3 -8.2 -7.2 -6.2 -6.0



of the GIIF bank.


External Sector: Recent Developments

The gradual narrowing of the current-account deficit that began in late 2011 intensified through the first five

months of 2012. In JanuaryMay, the current-account deficit dropped to USD27.051 billion, more than USD9.9 billion

smaller than it had been in the same period of 2011. In the first five months of the year, merchandise imports fell 0.8%

year-on-year (y/y), facilitating the decline in the overall current-account imbalance. In spite of weak demand from the

EUTurkey's biggest trade partnermerchandise exports managed to grow a vigorous 13.3% y/y, buoyed by increasing

demand from Iraq and the rest of the Middle East. While the current-account balance improved y/y, the net flow of

non-debt-creating foreign capital worsened. Net foreign direct investment inflows dropped from USD4.748 billion in

JanuaryMay 2011 to just USD3.833 billion in the same period of 2012, while the net inflow of portfolio investment

plunged from USD15.039 billion to USD6.805 billion.


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The current-account deficit reached 10% of GDP in 2011, a historically large shortfall for the country. The

current-account gap had been rapidly widening vis--vis year-earlier levels throughout the first 10 months of 2011, with the

countrys overall shortfall nearly doubling in nominal US dollar value. However, in the final two months of the year, the

efforts of the Central Bank of the Republic of Turkey (CBRT) to reduce the current-account deficit finally began to show

dividends, the headline current-account deficit narrowing first by 8.5% y/y in November and then by 12.8% y/y in

December. The USD77.089-billion current-account deficit for 2011 is equivalent to right at 10% of GDP. The shortfall is

dangerously large and is the highest such gap ever recorded for Turkey. As the year came to a close, the deterioration of

the merchandise trade deficit slowed, facilitating the turnaround in the headline current-account balance. Import growth

slowed sharply in the final months of the year in response to an effort to stem domestic demand. This slowdown would

have had an even greater impact if not for a similar deceleration of export growth due to the worsening of export

conditions to the rest of Europe. Also contributing to the narrowing of the current-account deficit in the final months of the

year, income outflows dropped off precipitously in the latter stages of 2011.

While Turkeys current-account deficit worsened substantially in 2011, inflows of non-debt-creating financing

improved to offset some of the increased danger. The net inflow of foreign direct investment (FDI) and of portfolio

investments both soared vis--vis their 2010 levels. Nevertheless, the improvement in non-debt-creating capital inflows

was only enough to offset about one-third of the worsening in the current-account deficit. As such, the difference was

made up by a rise in debt and a reduction in reserves (whereas in 2010, the country added significantly to its reserves).

Additionally, the countrys errors and omissions line was much larger in 2011 than in the previous year, a reflection of

greater inflows of previously foreign-sheltered capital back to the country.

Economic Structure and Context: Development and Strategy

Economic Development

Until the turn of the century, Turkeys economy struggled through years of dichotomy, torn between a dynamic

private sector and a laggard quasi-public sector. Economic policy was caught between a deeply rooted tradition of

government control and market-oriented economic reforms. Remnant influences of state control proved to be problematic,

evident in the multiple crises the economy endured over the past 1020 years. State-directed lending through banks

regularly flooded the economy with liquidity, causing endemic inflation and undermining the value of the currency. A


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combination of subsidization and public-sector banks triggered excessive bad debt and chronic government indebtedness,

characterized by double-digit fiscal deficits. The economic system was further compromised by political instability within

the country. Torn between conservative Islamists, the fiercely secular military, and economic reformers, no politician or

political party had the unity to stand behind much-needed economic reforms until after the turn of the century.

The economy was characterized by a spate of stop-and-go economic development. Recession was repeatedly

experienced. Rising trade, current-account, and budget deficits, high foreign-currency borrowings by banks, and a

government at its domestic borrowing limits all put pressure on the lira, which triggered several administrative

devaluations. In 2001, the lira crisis delivered the government into the arms of the International Monetary Fund (IMF) with

a huge bailout package, accompanied by a raft of promises toward fiscal austerity and reforms, including theestablishment of a free-floating lira. The Turkish government continued to receive IMF support until 2008, following the

successful completion of a final stand-by agreement.

Since the 2001 bailout, economic policy provided the foundation for much more sustainable economic recovery.

Key to the success has been the measure of political stability afforded the country by the rise of a single-party government

controlled by the moderate Islamic Justice and Development (AK) Party. The AK Party, for their part, embarked upon

IMF-mandated reforms that have bolstered the independence of the financial sector and slowly have begun withdrawing

the government from the economy. Investors slowly began returning to the economy as the lira crisis faded, leading to

equity and bond price rises.

Economic Strategy

The coming to power of the AK Party solidified a reformist program aimed at breaking decades of corporate

mismanagement and ingrained, inflationary expectations. Those policies activated by the AK Party include:

A free float of the currency that redistributes stress on inflation control elsewhere among monetary authorities and

provides an early warning to potential balance-of-payment crises.

The central bank has been granted operating authority over interest-rate policy.

The government has maintained a large primary fiscal surplus, even though it has waned somewhat in recent years.

The interest costs of debt servicing exact a heavy burden, demanding ambitious surplus targets.

Inflation has been falling, now generally running at its lowest levels in over 30 years.

Widespread structural reforms have been undertaken, most particularly in the banking system.

Economic reforms were conducted in close consultation, if not always in exact harmony, with the IMF. Even given

the impressive progress made since 2001, the country remains vulnerable to international crises and relapses of itscrisis-prone history. In fact, reforms initiated since 2001 have helped to limit the severity of economic disruption. In

addition, with both a comfortable reserve base and flexibility within the currency, the authorities are much better equipped

to defend against exogenous shocks than they had been previously. This level of advancement was demonstrated during

the 200809 global economic crisis and the ongoing Eurozone debt crisis. While the country has been hurt by the weight

of the international downturn, enacted reforms have helped avert a larger collapse of the type seen in many other

countries of the region.

Economic Structure and Context: Demographics and Labor Markets

The Turkish population increased from 66.5 million in 2000 to an estimated 75.7 million in 2010 and is projected to

reach 83.9 million by 2020. Turkey has the second-largest population among European Union (EU) members or

candidate countries, after Germany. Nevertheless, despite its large size, the density of the population will remain

considerably lower (90 persons per square kilometer) than the average of the EU countries, estimated at around 118


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people per square kilometer. We expect that the process of urbanization will continue at similar rates to those witnessed in

the last several years. For comparison, the urban population reached 44 million people in 2000, or 65% of total population,

up from 60% some 10 years earlier.

The Turkish population is and will continue to be one of the youngest in Europe, with 58% of the population

below 30 years of age. According to a 2000 census, 32.8% of the population was under 14 years and 62% was in the

age group of 15-64 years. The number of elderlyrepresented by the population aged above 65 yearsgrew to 5.3% of

the total population. The number of people below 30 years of age is projected to increase to 41.7 million by 2015, but their

share of the total population will decrease to 51%. From 1999 to 2015, this represents a total fall of 14% in this age

bracket.There are those who believe theOfficial unemployment in the country is given at around 1015% of the workforce.

true level of unemployment within the country is underreported and the real level is actually five percentage points higher.

On the other hand, extensive black market operations may make actual unemployment much lower that what is officially

reported, with many workers operating outside of official measure. Another potential cause for the difference in

unemployment rates is accounted for by differing estimates in the labor participation rate. At a little less than half the total

population, Turkey has one of the lowest labor participation rates in the Organisation for Economic Co-operation and

Development (OECD), a figure that has actually been in decline over recent decades. This low participation rate is

primarily due to the lack of female participation in the economy, a problem that is only slowly being addressed. As more

women enter the labor force, demand for employment will rise, putting further stress on the countrys lack of job creation.

Unemployment levels have been slow to fall with public-sector restructuring, particularly with reference to state and

quasi-state concerns.

Economic Structure and Context: Monetary System

The central bank works in autonomy to meet government inflation targets. The governor is appointed to a five-year term by

the prime minister, as approved by the president. With the appointment of the previous governor, Durmu Yilmaz, in early

2006, worries were high that the central bank might fall under too much control of the government. Yilmaz proved to be an

able governor, earning extremely high marks for guiding the country through the 200809 global financial crisis. The

Central Bank of the Republic of Turkey (CBRT) was among the most aggressive central banks in the world in acting to

offset the negative effects of the global economic crisis in 200809.The current governor, Erdem Bai, has faced greater

scrutiny given the central bank's more unorthodox monetary policy in 2011 to address overheating concerns. Worries have

once again arisen that the CBRT governor is operating under too much pressure from government quarters. Nonetheless,

institutionally, the bank remains strictly independent.

The central bank maintains the Turkish currency, the lira, on a free float. Nevertheless, it will intervene against what it

regards as unjustified corrections regarding the lira. The central bank utilizes interest-rate manipulations as well as a

whole breadth of monetary policy tools to affect the lira's value.

Economic Structure and Context: Financial System

The banking sector had been the economy's Achilles' heel until 2001, but it has since been exactly the opposite, a source

of strength. Prior to 2001, state-controlled (or more accurately, party-controlled) banks bankrolled nationalized industries

to the cost of growing bad debt. The creation of the Banking Regulation and Supervisory Agency, in line with the

International Monetary Fund (IMF), put the cost of cleaning up the banking sector's bad debt at a little short of USD50

billion in 2001, around one-third of GDP at that time. After significant privatizations and asset-sheet clean-ups, the banking


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system under the country's credit package with the IMF is in a position of much better health. By 2005, non-performing

loans (NPLs) as a percentage of total loan assets were down to below 10%well under the near-30% level that NPLs

reached in 2001. To achieve such improvement, the government allowed a significant influx of foreign participation,

although unlike many of the other countries of Central and Eastern Europe, the majority of banking assets remained in

Turkish hands, limiting the country's exposure to the European banking debt problems of 2009 and 2010. In fact, the

country's financial system came through the global crisis with flying colors, providing a source of potential growth for the

near future. In 2011 and now into 2012, there are worries that the banking system is once again facing troubles, with asset

quality rapidly deteriorating because of the sustained, rapid expansion of the system. However, compared with the

banking systems of Europe, Turkeys remains relatively worry-free.

The bourse is relatively young, with the Istanbul exchange being founded in 1985. Although it remains extremely small and

of little impact on the economy as a whole, it is one of the livelier among emerging markets, with over half of stock traded

being held by foreigners. Foreigners have been able to trade unrestricted on the exchange since 1989. Indeed, one of the

weaknesses of the exchange has been a lack of domestic funds for investment, stifled by the heavy presence of banks

within the economy. Thus, during times when global capital is averse to riskier economies, the bourse takes a heavy hit. In

keeping with the nature of the rest of the economy, the exchange suffered from notable volatility in its beginning, although

it has been much steadier in recent years. There is the belief in the country that as banking reform continues, deeper

capital markets will provide a more solid financing base to further future growth.

Economic Structure and Context: Key Sectors

Turkeys industrial sector is well developed. Main areas of specialization include textiles and clothing, ceramics and

glass, steel, chemicals, and light consumer goods. The production of automobiles is a leading growth sector.

Turkey's vibrant manufacturing sectors complement well the energy-rich, new markets to its northeast around the

Caspian Sea, as well as established markets in the Middle East and Europe, to which it is uniquely positioned.

While the country's agricultural dependence is easing, it remains a significant source of value added to GDP.

Moreover, given the country's fertile and vast area, it will likely remain a significant contributor to the economy as a

whole for some time to come. The sector could benefit from greater technological transfers and improved

infrastructure, and it remains vulnerable to shifting weather conditions.

For other energy resources, Turkey is heavily dependent on imported oil and gas. Power capacity is set to increase,

but Turkey is not yet self-sufficient in electricity. The country hopes to become a key energy middleman between the

markets of Europe and the production of Russia and Central Asia.

Services are growing fast on the back of the media, transport, and tourism sectors. The tourism sector, in particular,

has been instrumental in helping the economy find greater balance on the external accounts, becoming a key earner

of foreign currency.

Turkey: Top-10 Sectors Ranked by Value Added

2011 Level 2012 Percent Change Percent Share of GDP

(Bil. US$) (Real terms) (Nominal terms)

1. Agriculture 77.4 1.6 10.5

2. Real Estate 55.3 2.5 7.5

3. Retail Trade - Total 48.2 1.3 6.6

4. Wholesale Trade 44.4 2.7 6.1

5. Business Services 42.5 2.7 5.8

6. Communications 41.3 0.2 5.6

7. Construction 34.0 3.5 4.6


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8. Public Admin. and Defense 33.1 -0.9 4.5

9. Education 24.9 0.4 3.4

10. Land Transport 21.1 2.5 2.9

Top-10 Total 422.1 57.6

Source: World Industry Service, IHS Global Insight, Inc.

Updated: 17 Jul 2012

Economic Structure and Context: Natural Resources

Agricultural resources in the country are relatively rich in a series of diverse cereal, cash, and fruit crops. More specifically,

the country's agricultural production is greatest in tobacco, cotton, grain, olives, sugar beets, and citrus fruits. The country

is also the leading exporter of hazelnuts.

Substantial mineral reserves exist in copper, zinc, lead, and gold. The country is a leading global exporter of chrome.

Some oil deposits exist within the country, but are not enough to meet domestic demand. Natural gas deposits only supply

around 2% of domestic consumption. The country is developing itself to become a key transit point for Russian and

Central Asian raw energy products. More resources are being poured into further development of energy refining. The

country has substantial reserves of coal, estimated at around 1 billion tonnes.

Tourism potential in the country is considerable. Its diversity includes beach resorts to spectacular countryside, numerous

antiquities, and cosmopolitan cities.

Economic Structure and Context: Trade Profile

Turkeys trading patterns are undergoing significant changes. The evolution of Iraq in recent years has led to a rapid

resumption of trade with that country. The Iraqi market is fast becoming a key destination for Turkish exports. Additionally,

the country has been aggressive in building up its markets in both the Middle East and Africa, attempting to broaden itsexport base. As a result, trade with the United Arab Emirates has soared. Turkey is trying to mimic its success in sending

goods to the United Arab Emirates with the other countries throughout the Arab world. Otherwise, the countries of the

European Union (EU) and the United States are the countrys primary trading partners. On the import side, cheap Chinese

imports are securing an increasing share of total imports into the country. In addition, new energy pipelines from Russia

and Central Asia are causing trade with those countries to grow rapidly.

The makeup of Turkeys commodities trade is also evolving. Chinese imports received a boost at the beginning of 2005

with the cessation of textile and apparel restrictions. The ending of these international restrictions have undermined

Turkeys ability to export its own apparel and textiles to the rest of Europe and the world, with it now facing greater

international competition. Prior to the current economic crisis, the country had been rapidly increasing as an automotive

exporter. Energy imports and exports are growing rapidly, as Turkey is positioning itself to be a key trading point between

the crude energy providers of Russia and Central Asia and the Middle East and the markets of Europe.

Turkey: Major Trading Partners, 2010

EXPORTS IMPORTS

Country Billions of USD Percent Share Country Billions of USD Percent Share

Germany 11.5 10.1 Russia 21.6 11.6


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United Kingdom 7.2 6.3 Germany 17.5 9.5

Italy 6.5 5.7 China 17.2 9.3

France 6.1 5.3 United States 12.3 6.6

Iraq 6.0 5.3 Italy 10.2 5.5

Russia 4.6 4.1 France 8.2 4.4

United States 3.8 3.4 Iran 7.6 4.1

Spain 3.6 3.1 Spain 4.8 2.6

United Arab Emirates 3.3 2.9 South Korea 4.8 2.6

Iran 3.0 2.7 United Kingdom 4.7 2.5

Source: IMF, Direction of Trade

Turkey: Major Trading Partners, 2000

EXPORTS IMPORTS

Country Billions of USD Percent Share Country Billions of USD Percent Share

Germany 5.2 18.6 Germany 7.2 13.2

United States 3.1 11.3 Italy 4.3 7.9

United Kingdom 2.0 7.3 United States 3.9 7.2

Italy 1.8 6.4 Russia 3.9 7.1

France 1.7 6.0 France 3.5 6.5

Netherlands 0.9 3.1 United Kingdom 2.7 5.0

Spain 0.7 2.6 Spain 1.7 3.1

Israel 0.7 2.3 Belgium 1.7 3.0

Belgium 0.6 2.3 Japan 1.6 3.0

Russia 0.6 2.3 Netherlands 1.6 2.9

Source: IMF, Direction of Trade

Medium- and Long-Term: Outlook

A protracted malaise in the European Union will slow Turkish economic growth in the next several years.

Merchandise exports and capital investment inflows will be subdued in 201214 as Turkeys major partners in Europe dig

out from the current Eurozone debt crisis. Not all forward growth momentum will be lost, however. Turkey has diversified

both its trade and investment partnerships to include more of the Middle East. Thus, a collapse of demand and investment

from the European region does not leave Turkey devoid of activity, although it does severely reduce these levels.

Moreover, as of mid-2012, the central bank seems to have successfully navigated a soft landing for the economy, avoiding

the crash that might have accompanied the correction of the current-account deficit.

After this short-term economic slowdown, however, the Turkish economy remains relatively well equipped for

sustained, strong expansion in the longer term. With a well trained and underutilized labor market, an advantageous

geopolitical location with warming, albeit sporadically, ties with Europe, low interest rates, and an improving bureaucracy,

fixed capital investment growth should recovery relatively robustly in the medium and longer term. Additionally, consumer


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credit penetration is still relatively low in the country, particularly the use of credit cards. The banking sector is stable and

eager to expand consumer credit opportunities, so once the current regional malaise lifts, consumption growth could

revive rapidly. This comparatively strong medium-term outlook for domestic demand has a rather large drawback in that it

will prevent a rapid improvement in the dangerously large current-account deficit. The government will need to do a better

ob attracting more stable foreign direct investment inflows to help financing the sure-to-be large gap through the next

several years. To address the current-account deficit, structural reforms are needed to make the country less import

dependent, while a greater effort to contain domestic demand is needed. The government is promising such reforms, but

much must be done before a meaningful change is noted. For now, financing the current-account deficit is a major risk for

the country, particularly as incoming capital will be diverted in the short and medium term to finance still-large fiscal gaps

and onerous debt-repayment obligations.

Turkey's longer-term economic outlook remains clouded by continuing doubts regarding the country's prospects

of membership in the EU. When the accession process formally began in October 2005, it was widely assumed that the

path would be long and fraught with problems. Final accession was initially widely assumed to come no earlier than 2015.

Nevertheless, even these relatively guarded assessments of the process have proven to be extremely optimistic, as

rumors of potential derailment of the process have persisted in both Brussels and Ankara. Right now, it is unlikely that the

country will actually achieve EU membership for the foreseeable future (certainly not any sooner than 10 years out). In

recent annual reports regarding Turkish accession, the European Commission criticized a lack of movement on several

key reform areas. The 200809 global crisis and ongoing Eurozone crisis only served to derail needed reforms further,

particularly privatization efforts. Moreover, continuing institutional crises within Turkeybetween the government and the

military, between the government and the judiciaryfurther undermine forward momentum, suspending potential progress

in reforms. Although EU-based reports have remained relatively optimistic about both the overall movement toward

accession and the prospects, an impasse over Turkeys refusal to recognize Cyprus has created a significant stumbling

block. Even without the Cyprus issue, doubts from within the EU, particularly France, are growing, potentially forcing an

early ultimatum as to the accession process. It is now increasingly possible that the accession process might be

terminated from either the EU or the Turkish side, as Turkish citizens are growing disaffected from the movement, largely

as a reaction to EU hesitation. If the overall accession process is derailed, the medium-term economic forecast would be

affected. Nevertheless, our baseline expectation is that these negotiations will indeed continue, although not necessarily to

ultimate fruition. In any case, the general push of reforms that we assume will happen to facilitate EU accession will likely

continue, regardless of the official EU prospects for Turkey. If accession is formally off the table, we expect that the

Turkish economy will continue to become integrated with that of the EU. In fact, denial of full membership, which politically

could be severely damaging, may free the Turkish economy somewhat, allowing the country to avoid some of the more

restrictive or burdensome reforms demanded by the EU.

As the economy evolves to become more integrated with the EU, the value-added contribution to GDP will shift

significantly. Services are expected to grow the most rapidly over the medium and longer term, as the countrys tourism

undergoes a radical transformation and evolution. The country is aggressively attempting to de-emphasize agricultural

production, hoping to relocate agrarian workers into higher-technology and higher value-added manufacturing sectors.

The 200809 economic downturn set this process back somewhat, with a loss of industrial employment once again

pushing agricultural employment upwards. Nevertheless, we anticipate that the push towards higher technology will once

again resume, driving down the influence of low-tech sectorsin particular textiles and clothing. Economic development

will center on Istanbul but increasingly push to the east. The countrys position as an energy middleman will continue to

develop, with investment flows heavy in developing new energy pipelines to bring in raw energy products from the East

and to export refined energy products to the West. As such, Ankara has been aggressive in signing deals that deliver

Central Asian gas to European markets.

As discussed previously, the substantial current-account deficit will present severe downside risks to the

country's sovereign debts throughout the short and medium term, only slowly easing in the longer term. Although

the recovery in import demand in the short term will be sharply stronger than the subsequent revival in exportspartly due

to the stronger lirawe nonetheless expect export growth to recover fully further out, contributing to a slow narrowing of

the current-account deficit in the longer term. Nevertheless, given that the deficit will remain fairly large for quite some time


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at 3.0% of GDP or more until around 2025, financing will remain a major threat to Turkish stability. As such, external debt

will remain a constant threat, potentially running up rapidly if investment inflows are ever compromised. Slowly, an influx of

more substantial foreign direct investment inflows should help alleviate the country's reliance on debt financing. These

foreign investment inflows will also help to buoy longer-term economic growth, bringing with them technology transfers that

should help boost the country's productivity levels.

Analyst Contact Details: Andrew Birch

Sovereign Risk - Economic

Surging Gold Exports to Iran Contribute to Sharp Reduction in Turkish Trade Deficit in H11.

01 AUG 2012

Economic

Turkish Leading Production Indicators Support Soft Landing Expectation2.

26 JUL 2012

Economic

Turkish Central Bank Keeps Interest Rates Unchanged But Increases Domestic Liquidity3.

20 JUL 2012

Economic

Turkish Consumers Remain Wary Despite Modest Labour Market Gains4.

17 JUL 2012

Sovereign Risk - Economic

Turkey's Current-Account Deficit Continues to Narrow Sharply, Buoying Domestic Markets5.

12 JUL 2012

Turkey: Country Reports - Recent Analysis


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Economic

Turkish Growth Indicators Continue to Surprise on the Upside Although Budget Data Disappoints6.

10 JUL 2012

Economic - Country

Turkey's GDP Growth Surprisingly Strong in Q17.

03 JUL 2012

Economic

Leading Production Indicators Suggest Significant Turkish Slowdown in Q28.

26 JUN 2012

Economic

Turkish Central Bank Keeps Interest Rates Steady Once Again in June9.

22 JUN 2012

Economic - Sovereign Risk

Moody's Upgrades Turkish Sovereign Risk Rating to One Notch Below Investment Grade10.21 JUN 2012

Created on 02 Aug 2012

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