Violence in the south-east stifles businessesCollapse of the Kurdishpeace deal has driveninvestors awayPage 3

FT SPECIAL REPORT

Investing in Turkeywww.ft.com/reports | @ftreportsTuesday November 29 2016

Inside

Erdogan presses banksto keep lendingThe president continuesto demand boosts toconsumer spendingPage 2

The long-term viewPE investors see value ina youthful populationand domestic demandPage 2

Corporate debt bulgeCompanies with highlevels of foreign debtfear potential rate risesPage 4

F und managers of the world,here is an interesting invest-ment proposition: considerTurkey. Its president, RecepTayyip Erdogan, wants to hold

a referendum proposing to cut ties withitsbiggest tradingpartner, theEU.

He has sent troops into the quagmireof Syria’s civil war and is itching to join abigger fight inMosulandRaqqa.

After a failed coup attempt in July, hehas jailed his political opponents, shutdown dozens of news outlets critical ofhis policies and isolated a large swath ofhis country in the Kurdish south-east,shutting off the internet for days andarresting localpoliticians.

He rules by decree, under a state ofemergency, and has confiscated morethan $10bn in assets in the past fivemonths from the many companies runby people he considers disloyal, effec-tively making the Turkish state one ofthe nation’s largest conglomerates. For-eign investment is down, the lira hasfallen to record lows and the country’ssovereign debt is rated junk by two outof thethreemajoragencies.

So unnerving is the current state ofaffairs that a single, unsourced andprobably false article in the pro-govern-ment newspaper, Sabah, caused a nose-dive in shares of the listed units of theregion’s largest food manufacturer,Yildiz Holding. The newspaper hinted

at links between an unnamed high-pro-file company and the exiled Islamiccleric Fethullah Gulen, whom the gov-ernment accuses of orchestrating thecoup attempt. The next day, tradersdrove down shares in Yildiz, the makerofGodivaandtheUK’sUnitedBiscuits.

But all this chaos is temporary, saythose who remain confident about Tur-key’s fundamental economic strength,and with growth of about 3 per cent thisyear, theargument ishardtodismiss.

The country’s investment climate is“clouded, yes, that’s the right word”,says Ilhami Koc, chairman of the Turk-ish Capital Markets Association, an

industry group. “Fundamentally, thepromise of this country is still there, butit is clouded in the eyes of investorsbecause of terrorism, and then this[attempted]coup.”

Investor confidence will return, MrKoc says. “If there is a good settlementin that region [Syria and Iraq], then thispart of the world could be a centre ofinvestment,”hesays.

That, in essence, is the promise MrErdogan is making to his nation: in acountry rocked by instability, the solu-tion is for the people to hand him morepowers, to make him, constitutionally,the most powerful leader the country

Cracks in a growth story start to showThe president is askingTurks to hand him morepower in exchange for abright economic future,writes Mehul Srivastava

has known. If Turks assent quicklyenough, via a referendum expected totakeplacebyspring2017,hepromisestorestore peace and stability to the nation,and with peace will come the return oflong-term economic prosperity. Newbridges will soar, he says. Railway tun-nels will burrow, highways will criss-cross the country, investors will realiseanew the potential of a young middleclassandthemallswillbe fullagain.

As one economic journalist, Abdur-rahman Dilipak, tweeted last week tohis half-a-million followers: “Resist thecrisis, continueshopping.”

Continued on page 3

Comment Could Trumptrample economic hopeAnkara’s glee over theprospect of a Trumppresidency is ill-judgedPage 4

Unrest: Business,especially in theKurdish south-east (above), hasbeen hit by atumultuous yearIlyas Akengin/AFP/

Getty Images

As oneeconomicjournalisttweeted lastweek: ‘Resistthe crisis,continueshopping’

On a recent trip to Britain, Nihat Zey-bekci, Turkey’s minister of the econ-omy, was asked what he thought of theUK turning its back on the EU throughits June23referendumtoleavethebloc.

“I don’t see it that way,” Mr Zeybekcireplied. “I think you could rather saythat the EU failed to retain the UK as amember. From the EU point of view, ofcourse, it is a loss, but are we concerned?No, on the contrary. We see it as anopportunity.”

Some might say the minister’s wordsshowed an advanced ability to look onthe bright side. Turkish officials arealready working on a “new generation”free-trade agreement with the UK to beconcludedsimultaneouslywithBritain’sdeparture from the EU. It would be “oneof the most comprehensive” trade dealsTurkeyhassigned.

Others might argue his response wastypical of a country where events thatwould bring other economies to a stand-still canapparentlybeshruggedoff.

ThisyearaloneTurkeyhassufferedatleast three serious terrorist attacks, achange of prime ministers, spats withGermany and the EU, a failed coup, theclosure of dozens of media outlets, theseizure of hundreds of private compa-nies, arrests of opposition politiciansand the continuing spillover from con-flictsacross itsborders.

“It is natural for people to ask ques-tions about these things,” says MahmutUnlu, chairman and chief executive ofUnlu & Co, a financial advisory firm.“But throughout the whole geopoliticalsituation, the government has beencommitted to business. Turkey’s macrofundamentals have not been affected.Everything else maybe, but not themacro.”

Turkey’s economy has consistentlygrown at 6, 7 or 8 per cent a year formuchof thepast twodecades.Evenwithslower growth of about 3 per cent thisyear, it is one of the few middle-incomeeconomies in the world showing thatkind of performance. While its mone-tary policies have often mystified andinfuriated analysts and investors, thegovernment’s fiscal discipline has been

beyond reproach: its budget deficit,averaging about 1.5 per cent of GDP forthe past six years, would be the envy ofmostwesternEuropeancountries.

Investors continue to be attracted byTurkey’s demographic advantage: 80mpeople, with an average age of 29 and anapparently unstoppable propensity toconsume.

This alone, for many, is good reason tolook beyond the political turmoil.“From a business perspective, it is partof the country’s DNA to be a bit unpre-dictable sometimes,” says RobertoPedretti, chief executive for central andeastern Europe and Turkey at Nielsen,the consumer research company. “Thebeauty of this country is that if you lookat it in the long run, rather than quarterbyquarter, theresult isalwaysgood.”

It may not be what investors are usedto,MrPedretti says,but that isonly tobeexpected. “Turkey has a velocity thatwe do not see in many European coun-tries,” he says. “Poland is definitely amore stable and less risky environment

than Turkey, but the growth opportuni-ties inTurkeyaregreater.”

As investors know only too well, how-ever, past performance is no guide tofuture returns. Many are wonderingwhether, this time, the uncertainty willcausemore lastingdamage.

Atilla Yesilada, co-founder of IstanbulAnalytics, a consultancy, says foreignexecutives are increasingly nervous. He

was called to one western embassyrecently to answer questions frompotential investors.

“The most frequent question was,‘How do we know the government won’tattackourassets?’”hesays.

“I think that is an undue concern, butwith more than 500 companies takenover without due process, people won-der. A country at our stage of develop-ment needs a good judiciary and goodstandards of governance and they arenotprovidingthat.”

The problem, in Mr Yesilada’s view, isnot that the government does not graspthe importance of business. With no oiland few other natural resources beyondtourism — an industry that has been hitby terrorist attacks — the economydependsoninvestment forgrowth.

Mr Unlu insists that investors havenot been put off. He says that anecdotalevidence suggests foreign direct invest-ment has picked up over the past monthor two. “There was a three or four-month hiatus and that will lead to a fallin FDI this year,” he says. “But there willbenolasting fall in investment.”

The government has been alive to therisks of post-coup turmoil, movingquickly after the attempt to pumpliquidity into the banking system anddraw up and send to parliament a seriesofpro-businessreforms.

“The government is trying to instilconfidence in investors and they arevery diligent . . . meeting companies athome and abroad and passing new legis-lationonadailybasis,”MrYesiladasays.

“But theydon’tunderstandthere isnopolitical certainty.Theythinkwhat theyare doing is good for the people and forsecurity and they don’t understand whyit isn’tattracting investment.”

Ankara seeks to lift confidenceafter a turbulent yearEconomy

Investors are betting on thefundamentals to deliverreturns, writes JonathanWheatley

Nihat Zeybekci, minister of the economy — Orhan Cicek/Getty Images

‘The beauty of this countryis if you look at the long run,the result is always good’

2 ★ FINANCIAL TIMES Tuesday 29 November 2016

Investing in Turkey

M easured by fundraisingand investment, Turkeyhas pretty much fallen offthe private equity map in2016.

According to the Emerging MarketsPrivate Equity Association (EMPEA),nonewPEinvestmentfundswereraisedin Turkey in the first half of the year andjust$3mwasinvestedinfourdeals.Thatcompares with $104m invested in 19deals last year and a recent peak of$569min28deals in2011.

Anthony Stalker, partner and chiefinvestment officer at ADM CapitalEurope, admits that investment hasbeen slowing and fundraising has beendifficult. Investors, he says, have beenput off by the violent and destabilisingevents that have dominated headlinesin Turkey and Europe. With electionslooming in France and Germany, whereregionalmigration isset tobeabig issue,news coverage casting Turkey in a poorlight isunlikelyto improve.

“The geopolitical news couldn’t havebeen much worse and the headlines arenot going to get any better,” Mr Stalkersays. “That puts people off.” The factthat the lira has lost about 45 per cent ofits value against the dollar since 2012onlyaddsto investors’ fears,hesays.

But, Mr Stalker says, PE investorsshould focus on the opportunitiesdriven by Turkey’s long-term growthstoryratherthantherecent turbulence.

“We have been in Turkey since 2005and there has been dramatic change,especially in the small to mid-cap sec-tor,” he says. “This is a thriving businesscommunitythatoffersrealgrowth.”

As well as having a young populationand strong domestic demand, Turkey isemerging as a genuine manufacturing

base for Europe, he says. He cites ADMCapital Europe’s investment in CevherDokum, a maker of aluminium castingsfor theautomotive industry.

ADM and its partner had been due tosell their stake to Nemak, a Mexicanauto parts maker, on July 17 — two daysafter the coup attempt. “All parties,wisely, decided to step back and see howthings played out,” he says. Five weekslater, the parties agreed to go ahead. Thedealwascompletedthismonth.

“This is a classic case of a companytaking a long-term strategic view and itillustrates my main point,” says MrStalker. “To invest in Turkey, you needto take a view that, over the next five to10 years, very favourable demographicswill continue to support positive growthin domestic demand as well as buildingamanufacturinghubforEurope.”

Selcuk Yorgancioglu, a partner inIstanbul at the Abraaj Group, an emerg-ing market PE firm, goes further, sayingbusiness in Turkey goes on almost unaf-fectedbygeopolitical turmoil.

He says Abraaj closed its latest invest-ment fund, having raised $526m, oneweek after July’s coup attempt (andtherefore outside EMPEA’s figures forthefirsthalf).

It has made two investments out ofthe fund in the past two years — a 25 percent stake in ecommerce company Hep-siburada and a 10 per cent stake in

Fibabanka, a bank. Abraaj now plans tomake five more investments with themorethan$300mremaining.

All Abraaj’s previous investments inTurkey, from 2008 onwards, were soldby 2013. “Good businesses can be exitedat all times,” Mr Yorgancioglu says. “Butright now we have nothing to sell. That’snotaquestionof luckbutofprudence.”

Meanwhile, he says, Abraaj’s invest-ments are beating expectations. Hepsi-burada’s revenues, he says, will grow by110 per cent in lira terms this year —“whatever the depreciation, [that is]stillbiggrowthindollar terms”.

But not everyone is as positive. OzgurAltug, economist at BGC Partners inIstanbul, says some private equity dealsare still going through, as Turkey’s eco-nomic slowdown leads some businessesto lookforbuyers.

Sellers of business assets in Turkey donot often drop their prices at times ofdifficulty, he says, but they may nowfind they need cash, or a partner, to seethemthroughdifficult times.

“The opportunities for private equity

are there,” he says. “People see the slow-downandsay, ‘That’smyopportunity.’”

Despite the upbeat tone from PEinvestors, there is no escaping theEMPEA numbers and their clear por-trayal of an investment environmentthat, isolated examples apart, is at anearstandstill.

For the economy as a whole, privatesector investment declined by 1.2 percent in the first half of this year, accord-ing to the central bank, after growing atdouble digit rates for much of the past20years.

Public sector investment is still grow-ing quickly — at 4.5 per cent in the firsthalf—butthat isnotenoughtooffset theslowdownintheprivatesector.

“The issue is confidence,” says MrAltug. “If we can find something thatwill lift all these dark clouds hangingover Turkey we will have a chance. Buttheheadlineseveryday,about thepresi-dential system, the death penalty, thecross-border situation, the purges, thearrests — all this affects people’s willing-ness to invest.”

Investors arestill betting onprogress inthe long termPrivate equity Favourable demographics suggest arosier future is possible, reports Jonathan Wheatley

Turkey’s appeal as a destination forforeign direct investment has been putto the test in recent months by a hostof geopolitical challenges, securitythreats and internal tensions.

This summer’s failed coup attemptand subsequent crackdown againstthe perceived enemies of PresidentRecep Tayyip Erdogan has only addedto a mounting sense of instability.

The country’s temptingly largedomestic market, low costs andconvenient location straddling Europeand Asia, have made it historicallyattractive to foreign investors. It haswon more than $232bn in total FDIsince 2003, compared with $68bn forthe whole of neighbouring south-eastEurope, according to data fromUnctad, the UN’s trade anddevelopment arm.

But headline inflows to Turkey haveebbed in the first nine months of 2016,according to Turkey’s central bank,which reported $7.1bn betweenJanuary and September this year,compared with $13.3bn over the sameperiod in 2015.

This decline, though steep, is notunique to Turkey. Unctad expects a 15to 20 per cent global decline in FDI in2016. “We do not expect anyrepercussions in Turkey’s FDI flow [asa result of the coup],” says IsmailErsahin, deputy executive director ofthe Istanbul-based World Associationof Investment Promotion Agencies(WAIPA). “Quite the opposite. Weexpect FDI figures to gain momentumin the last quarter of 2016.”

Deputy Prime Minister MehmetSimsek expressed a sanguine view at aWAIPA event in Istanbul in October:“Headline-wise, clearly the news storyremains a mixed picture to negative,”he said. “Of course there will beeconomic fallout, and that is alreadyreflected in our medium-termeconomic forecasts. [But the fallout] islikely to be limited and shortlived.”

Multinational companies makinggreenfield investments — classified ason-the-ground investments involvingthe creation of a physical facility withnew local headcount in a foreigncountry, or the significant expansionof existing facilities — have shownsome patience with Turkey’s troubles.

After a dip in 2014, the number ofgreenfield projects announced orlaunched in Turkey and the total

estimated capital investment in thoseprojects rebounded in 2015, accordingto fDi Markets, an FT data service.There were 157 greenfield projects in2015 totalling $6.1bn, compared with108 worth $5.6bn in 2014.

As of the end of October, fDiMarkets has tracked 89 projects worth$3.6bn that have been announced orlaunched this year. Seventeen of thoseannouncements came after July’s coupattempt and among them was the US-based food and beverage giantPepsiCo, which last month announcedplans to open a new $120m foodproduction facility in the eastern cityof Manisa, employing 350 peopleinitially and more than 500 by 2022.

Henry Loewendahl, the Turkey-based chief executive of FDIconsultancy Wavteq, expects thatforeign investment related to thetourism and real estate sectors inTurkey will continue to fall until long-term security has been restored.

The continuation of Turkey’s EUintegration process is anotherimportant precondition. Manycompanies use Turkey as an exportplatform for the EU, taking advantageof its customs union with the bloc.

The non-binding vote by theEuropean Parliament last week, callingfor the freeze of accession talks, hasput that process under threat.

“The vote will increase the politicalrisk premium of investing,” MrLoewendahl says. “Given Turkey issuch an important market for EUbusiness, we don’t see significant risksto the customs union, but if accessionnegotiations are formally frozen,export-oriented FDI may shift tocentral and eastern Europe and othercountries like Morocco.”Courtney Fingar

FDIInvestment faltersas tensions mount

Short view: currency exchange boards in Istanbul — Chris McGrath/Getty Images

‘The issue is confidence. Ifwe can find something thatwill lift all these dark clouds,we will have a chance’

Investorshavegoodreasontobeconcernedaboutaspectsof theTurkisheconomythesedays.

The listofdomesticchallenges is long:political tensionsarerunninghighathomeandinternationally,while thecurrentaccountdeficit iswideningagain—despiteasharpslowdownineconomicactivity thatmay, inthethirdquarterof2016, leadtothefirstnegativeGDPgrowthfigures insevenyears.

Witha largeexternal financingrequirementanddollar-dominatedexternaldebtstructure,Turkeyisparticularlyvulnerable tothehigherUSyieldsandstrongerdollarexpectedunderaTrumppresidency.

Theseglobalanddomesticchallengeshaveall takentheir tollontheTurkishmarkets,withthecurrencybearingthebruntof thepressure.The lirahasdepreciatedbyaround15percentagainst thedollarsincethebeginningoftheyearmaking it thethirdworst-performingemergingmarketcurrencyafter theMexicanandArgentinepesos.

But thefact thatTurkeyisnotperformingevenworsethanit is rightnowis thankstotwofactors.

First, thegovernment’s fiscal stancehasbeenconservative.Asaresultofcontinuingfiscaldiscipline, thepublicdebt-to-GDPratiohas fallenalmostcontinuouslysinceTurkey’s2001economiccrisis. Itnowstandsat just33percent,nearlyhalf the60percentupper limitmandatedbytheMaastrichttreaty forEUmemberstates.Evenwiththepredicted looseningof fiscalpolicyin2017, thebudgetdeficit isexpectedtowidentoonlyaround2percentofGDP,accordingtothegovernment’smedium-termprogramprojections.

Thesecondfactorhasbeenthestrengthof theTurkishbankingsystem.Thiswasnotalwaysthecase:duringthe2001crisis, thebanksweretheweaklinkthatpropagatedshocksacross theeconomy.ButTurkishbankershave

takenthe lessons fromthatcrisis toheart.Gonearethedaysof largeshort-FXpositionsandthebusinessmodelofrelyingonwholesale fundingfromabroadto lendtothegovernment. Infact,Turkishbanks’netFXexposureasofSeptemberthisyear ispracticallyzero.

Instead,Turkishbanksnowengage intheverytraditionalpracticeofcollectingdepositsandlendingtocompaniesandhouseholds, stayingawayfromfancybutriskyproducts.Theyhavebeendoingagoodjobofmanagingassetquality: thenon-performing loansratioof thebankingsystemstandsat3.3percent—Italy’sratio is17.5percent,accordingtoIMFfinancial soundness indicators.

Turkishbanksalsohaveampleprotectionagainstadeterioration inassetquality; thecapitaladequacyratiois16percent—doubletheminimumsetbytheBaselAccord—implyingthat thebanksretainsubstantialbuffers toabsorbshocks.

But thestrengthof thebankingsystemisnotonlyabout financialcapital;humancapital isavery

importantpartof thestory.AccordingtotheTurkishbanks’

association,85percentofpeopleworking inbankshaveuniversityorpostgraduatedegrees.Notonlythat,but, inacountrywhereonly26percentofnon-farmworkersarewomen, thebankingsectorhasafemaleemployeeratioof51percent.

Thiswell-capitalisedsystemisnowanimportantpillarunderpinningthestabilityof thewidereconomy.Butbanksdonotoperate inavacuumandtheiraccess to foreigncapital isverymuchaffectedbytherestof theworld’sperceptionofTurkey.

Theynowfacespecificpressures:agovernmentpushtoacceleratecreditgrowthvia lower loanratescoulderodenet interestmargins.Thiscouldhindercapitalgenerationandfuture loangrowth—precisely theoppositeofwhatAnkara is tryingtoachieve.

Althoughbanksmaynotberunningshort foreigncurrencypositionsthemselves, theirclientsare,andthebanksaretherefore indirectlyexposedtotheFXrisk.Theshort foreigncurrencypositionthat thecorporatesectorrunshassofarnot ledtosignificantassetqualityproblemsforthebanks.But this isnoguaranteethatqualitywill remainunaffected if thedepreciationcontinues.

Eventhoughthebanks’capitalcushionsarestrong, thestabilisationofthecurrencywouldbeawelcomerelieffromfutureassetqualityconcerns.ButthatwouldrequireMrErdogan’sgovernmenttochange itsstanceoninterestratehikes.

TheTurkishbankingsystemmaybestrong,but its strength isnotsufficienttosafeguardoverallmacroeconomicstability.Bankswilldowhattheycantosupporteconomicactivity,but theywillalsoneedall thesupport that theycanget fromthegovernmenttoensuretheirmarginsarenotundulyerodedandthefinancialhealthof theirclients isnotcompromisedbythecontinuousdepreciationof thecurrency.

If thebankingsystemcannotget thatsupport, thisbrightspotwill fadetoo.

The writer is senior emerging marketseconomist covering Turkey at Nomura

A strong banking system alonecannot secure financial stability

COMMENT

Inan Demir

The lira fell to historic lows last week

Turkey’s economy is youthful, growing,modern and diverse. But above all, itsurvives on leverage, engorged with theforeign debt that flows through its cor-poratesector.

By contrast, Turkey’s banks are lessexposed to dollar debt: only 15 per centof their funding comes from borrowing,from local and foreign banks. A healthy53 per cent comes from customerdeposits according to the banking regu-lator, compared with an average forEuropean banks of 45 per cent, accord-ingtotheEuropeanCentralBank.

But this does not mean Turkish banksare immune from the country’s eco-nomic downturn. Analysts say non-per-forming loans, officially at 3.3 per cent,are, in reality, probably running at 6 percent or higher and they report signifi-cant political pressure on banks not toforecloseonnon-payingcustomers.

In private conversations, Turkishbankers fret. At a time when theyshould be reining in lending, they arelambasted by President Recep TayyipErdogan for betraying the country bysitting on capital. When they should beprotecting their bottom lines, they arebeing forced to drop lending rates tokeep the voters spending. When the lirahas proved to be the economy’s biggestweakness, the government has put pres-sure on the central bank not to tightenpolicytoprotect thecurrency.

“We are looking at a tough year,” saysone senior banker, who did not want tobe named. “If we’re not careful, we’relookingatahardlanding.”

Bankers talk of corporate customersstruggling to find collateral, with thechairman of one medium-sized com-pany allegedly offering the deeds of asummer house in France, and anotheroffering cash recently brought back toTurkeyunderataxamnesty.

“It is alarming how deep into theirpockets they have to search to keeploansalive,”onebankersaid.

The banks’ disclosed figures mayshow a measure of strength against abarrage of domestic and external chal-lenges. But the question is, how real isthatstrength,andhowlongcanit last?

Serra Akcaoglu, chief executive of Cit-ibank in Turkey and chair of AmchamTurkey, the US chamber of commerce,says it was the consolidation of the sec-

tor in the early 2000s — from whichemerged about 50 banks with strongfinancials — that has given the economyits resilience. But this year’s turmoil hasput that resilience to a severe test andcracks are beginning to show in thesector’sconfidence.

The latest edition of a quarterly sur-vey by the central bank, for example,points to a tightening of credit condi-tions among banks lending to the corpo-rate sector. The same survey found thatdemand for loans among consumers,

while holding in some sectors, has col-lapsed or turned out to be much weakerthanbanksexpected inothers.

Separate monthly data from the cen-tral bank show the annual rate of creditexpansion to the private sector fallingsharply this year, from nearly 20 percent at the end of 2015, to just 8 per centinSeptember.

Burcu Unuvar, of the department ofeconomics at Ankara’s Bilkent Univer-sity, says the data highlight a structuralweakness in Turkey’s economy: its lackof savings. The country’s saving rate, atthe equivalent of just 16 per cent of GDP,is low by international standards. Thatmeans Turkish households and compa-nies must borrow — either from lendersat home or abroad — to consume andinvest. “The level of debt is not the prob-lem,” she says. “The issue is the lack ofsavings. You can’t bet forever on peo-ple’swillingness toborrowandspend.”

With economic growth slowing thisyear, Ms Unuvar says, people fear losingtheir jobs and do not want to get furtherinto debt. Falling demand for credit, shesays, combined with a reluctance on thepart of banks to lend, has created a dan-gerous mix. “We have lost the engine ofgrowth,”shesays.

Yet banks now face new demands forfundingfromanunexpectedsource.

On November 21, the governmentbegan auctioning some 600 companiesseized from those accused of helping tofund Fethullah Gulen, the exiled clericwhom Mr Erdogan blames for anattempted coup in July. Lining up to buythose assets — valued at about $10bn —are relatively small companies, theirmajor qualification being loyalty to MrErdogan.They, too,willhope for favour-able treatment fromTurkey’sbanks.

Bankers fret asErdogan increasespressure to keepvoters spending

Banks

The president is lambastinglenders for sitting on capital,write Mehul Srivastava andJonathan Wheatley

53%Turkish banks’funding fromcustomer deposits

45%European banks’funding fromcustomer deposits

Deputy PM Mehmet Simsek

Consumer demand is falling

‘Banks do not operate in avacuum. Their access toforeign capital is affectedby perceptions of Turkey’

Tuesday 29 November 2016 ★ FINANCIAL TIMES 3

Investing in Turkey

L ife has begun to creep backinto Sur district, the ancientheart of the city of Diyarbakirin Kurdish-majority south-east Turkey. Throughout last

winter its basalt walls echoed with thesound of gunfire as state security forcesbattled youths linked to the KurdistanWorkers' party (PKK), a militia fightingfor greater autonomy and more rightsfor Turkish Kurds. In March this year,the violence abated and curfews begantobe liftedstreetbystreet.

Now, some shops have raised theirshutters. Cafés in the striped stone mar-ket square of Hasan Pasa Han are serv-ing breakfast again. Street vendors haveresumed trundling their wooden cartspiled with walnuts and powderedoblongsofTurkishdelight.

But the end of the recent clashes — thelatest in an insurgency that has beenfought on and off in the region since1984 — has not dissipated the gloomhanging over Diyarbakir’s businesscommunity. Fighting continues in themountains near the border with Iraqand police and military targets in citiesare being struck by retaliatory bomb-ingsbythePKK.

Alican Ebedinoglu, head of Diyarba-kir’sUnionofTradersandArtisans, saysthat before the collapse in July 2015 of atwo-year ceasefire there was a sense ofoptimism and momentum in Diyarba-kir province. “But it all went downhill,”he says. “Now we are experiencing theworsteconomicperiod inDiyarbakir.”

The south-eastern region has longbeen the country’s poorest. Educationlevels here are lower than the nationalaverage and the economy is dominatedby agriculture. In the 1990s, hundredsof thousands of south-eastern Kurdsfled to urban centres after being forcedfrom their villages — many as part of a

state effort to cut off support for thePKK,whoaredeemedaterroristorgani-sation by Turkey, the EU and the US.Millions more left in search of opportu-nities inwesternTurkeyorEurope.

“As far back as I can remember incen-tives [have been needed] to get busi-nesses to go to the south-east, and man-datory service to get public servants towork there,” says Nigar Goksel, Turkeydirector of the International CrisisGroup. “The region hasn’t benefitedfrom the economic momentum of thecountry,proportionately.”

This lack of economic opportunity isone of many factors that have fuelledlocal sympathy for the PKK. For dec-ades, bouts of violence have deterredboth foreign and Turkish investors and

dampedtheregion’sgrowthprospects.After coming to power in 2002, Presi-

dentRecepTayyipErdogan’s JusticeandDevelopment Party (AKP) gave greaterrecognition to the nation’s estimated16m Kurds and, in 2013, reached anunprecedented ceasefire with the PKK.The AKP government channelledmoney to the region, improving trans-port infrastructure, energy productionandhealthservices.

But while the south-east has subse-quently grown in prosperity, it still lagsbehind the rest of the country: GDP percapita for Diyarbakir province andneighbouring Sanliurfa province grewby about 80 per cent between 2004and 2011 (the latest figures available)to around $4,000, according to the

Turkish Statistical Institute. Over thesame period, the countrywide averagerose fromaround$5,000to$9,000.

The government blames the PKK,arguing the group has deliberatelythwarted state investment projects bydestroying machinery and threateningcompanies that invest in the south-east.Ankara’s opponents accuse it of a half-hearted commitment and of focusing itsmoney on building defence infrastruc-ture, rather than on projects to createandsustain jobs.

In recent years, growth has beenundermined by wars in neighbouringSyria and Iraq, two of the most impor-tant export destinations for the Turkishprovinces thatborderthosecountries.

After the collapse of the ceasefire last

summer, fighting erupted in south-east-ern city centres for the first time, whererearmed PKK-linked youths declared“autonomous zones”. The violence dis-placedanestimated350,000civilians.

Mr Ebedinoglu says that 1,000 busi-nesses have closed in the Sur district ofDiyarbakir since last summer and 5,000people have lost their jobs. Four out offive hotel beds are empty, he says, andbusinesses fighting to stay afloat arestrugglingtoobtaincredit.

Since July’s thwarted coup attempt,the government has sacked thousandsof Kurdish teachers, closed media out-lets and detained MPs from the largestKurdish opposition party, accusingthem of supporting the PKK. Internetservices were shut down in a bid to stifleprotests,hitting localbusiness.

Meanwhile, Ankara says the state andthe private sectors will plough 10bn lira(around $3bn) into rebuilding andreviving thecityofDiyarbakirandothersouth-eastern cities devastated by thefighting. Early this year, then primeminister Ahmet Davutoglu announceda plan to reconstruct Sur like the Span-ish city of Toledo. “Everyone will wantto come and appreciate its architecturaltexture,”hesaid.

But the reconstruction plan — whichinvolves bulldozing areas untouched bythe fighting — is controversial. Localsfear being forced from their homes intothe suburbs, in what they see as anattempt at demographic engineering toweaken PKK support. The governmentdenies this, but the lack of clarity ishampering those trying to get back ontheir feet.

Cahit Pekkolay, a local businessman,owns a portfolio of commercial prop-erty that now stands empty. “There is alotofuncertainty,”hesays.

Ugras Ulku, senior economist at theInstitute of International Finance inWashington, says that, in the long term,the region’s economy needs to shifttowards services and manufacturing.But he is not optimistic. “Such a shiftcould only be possible if more invest-ment could be channelled to developthe essential physical infrastructure inthe south-east,” he says. “That requiresa substantial improvement in the secu-ritysituation intheregion.”

Security fears stifle businesses in the south-east

Left behind: Lifeis beginning tocreep back intoDiyarbakir aftermonths ofviolenceIlyas Akengin/AFP/GettyImages

‘After theceasefireended, itwas alldownhill.Now we areexperiencingthe worsteconomicperiod’

Insurgency The collapseof President Erdogan’sKurdish peace processhas put investors offan unstable region,reports Laura Pitel

MediterraneanSea

BlackSeaBULGARIA

ARMENIA

GEORGIA

T U R K E Y

RUSSIA

SYRIA

IRAN

IRAQ

Source: Turkey Statistical O�ice* Latest data available

Turkey’s GDPper capita

3,515–4,952 4,952–5,904 5,904–7,232 7,232–10,122 10,122–13,865

2011 ($)*

Ankara

Istanbul

Diyarbakir

ContributorsMehul SrivastavaTurkey correspondent

Jonathan WheatleyEmerging markets writer

Laura PitelFreelance journalist

Courtney FingarHead of content, fDi Intelligence

Cordelia JenkinsCommissioning editor

Steven BirdDesigner

Michael CrabtreePicture editor

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Follow us on Twitter at: @ftreports

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His tone might have been tongue incheek, but it was not a bad argument,said a senior London-based financier ona recent trip to Istanbul. Investors didnot care if Mr Erdogan was autocratic,majoritarian or even if he eventuallybecame a dictator, he said. What theydidcareaboutwasstability.

“What you’re seeing right now is aperiod of chaotic transition,” he said,asking to remain anonymous. “Pushing,pulling, advancing, retreating — my cli-ents don’t like that. They want [to say],‘Be done with all this, and give us a callwhen you have become what you wanttobecome’.”

The transformation has been messy.After the failed coup attempt, MrErdogan assumed emergency powerswithin a week, granting him unques-tioned authority, in a rehearsal of therolehe isseekingpermanently.

In theory, with an incapacitated con-stitutional court (following the dis-missal of two of its members), hardlyany independent media to criticise himand few opposition leaders braveenough to challenge him, Mr Erdogan’stransition to an executive presidencyoughttohavebeensmooth.

Instead, while he began preparing thecountry for the referendum, the presi-dent had other battles to fight: theremoval of the Kurdish politicians heaccuses of fronting for terrorists, theexile, firing and imprisonment of thosesuspected of loyalty to Mr Gulen and thetaming and seduction of a nationalistopposition leadership, whose supporthe needs for the referendum to secureparliamentaryapproval.

These moves have resulted in globalconcern that has driven the lira lowerthanatanytimein itshistory.

In addition, Mr Erdogan is acting justas the world starts to prepare for the end

Continued from page 1 of the seemingly limitless liquidity thathas propped up emerging markets foryears.

After Donald Trump’s victory in theUS presidential election, given the long-anticipated prospect of a US interestrate rise, the Turkish lira appearedamong the least safe assets they couldhold. Instead, foreign investors havesought thesafetyof theyenandgold.

The retreat of that global flood ofmoney has exposed in Turkey whateconomists Barry Eichengreen andRicardoHausmannhavecalledan“orig-inal sin”, or the tendency of countries toborrow from abroad what they cannotgetathome.

For Turkey, the penance could be par-ticularly grim. In S&P Global’s OriginalSin Index, which calculates the degreeto which 15 of the world’s largest emerg-ing economies finance their public andprivate sectors in domestic currency,Turkey lies near the bottom, above onlyIndonesia,HungaryandArgentina.

One saving grace is deeply liquid for-eign currency spot markets. Oddly

enough, in a country where a scarcity ofdollars could one day tip over into a bal-ance of payments crisis, ATMs in Tur-key will pay out dollar bills and banksoffer accounts in dollars, euros andother foreign currencies, turning citi-zens into amateur currency day traders,tryingtooutrunthe lira’sdecline.

Turkey is certainly alone amongemerging markets in granting its citi-zens such unrestricted access to foreigncurrency. In the days after the coup

attempt, as the lira sank to what werethen historic lows, Turks sold $12bn oftheir holdings to buy local currency,arrestingthe lira’s slidetemporarily.

The lira has continued to fall sincethen, exposing companies to the dan-gersof theirdollar-denominated loans.

JPMorgan Chase thinks the rout is notover yet. Its analysts forecast that as MrErdogan pursues his executive presi-dency — and as Turkey’s structuralflaws are increasingly exposed in a lessliquid global environment — the liracould fall to 3.50 per dollar before theyear’sendand3.65bytheendof2017.

Mr Erdogan is well aware of this. LastWednesday, he presided over a meetingof the economic co-ordination board, inplace of his handpicked prime minister,and, on a day the lira continued its slide,lambasted the central bank for not tak-ingreal interestrates tozero.

The following day, the central bankdefied him, raising its benchmark ratefor the first time since 2014. The relieffor the lira was temporary: after theEuropean Parliament voted to suspendTurkey’s membership talks the sameday, thecurrencyfell toa fresh low.

This is the pattern investors canexpect to keep seeing in Turkey: a con-test between one of the weakest of cur-renciesandthestrongestof leaders.

Cracks in a growth storystart to show

Turkish lira

Source: Thomson Reuters Datastream

Against the dollar (lira per $)

Jun Nov2016

3.6

3.4

3.2

3.0

2.8

‘Now we are seeing pushing,pulling, advancing, retreating— my clients don’t like that’

4 ★ FINANCIAL TIMES Tuesday 29 November 2016

Investing in TurkeyInvesting in Turkey

W hen Donald Trump wonthe US presidency,investors immediatelyexpressed their views ofwhat the impact might

be on Turkey: the lira plunged, losing 7per cent of its value against the dollar inthespaceof10days.

What spooked investors most was notthe threat of protectionism that hasroiled other emerging markets, but theeffect an expected rise in US interestrates, under a Trump presidency, willhave on a country that is so heavilydependentonforeignfinance.

At the heart of the problem is corpo-rate debt. Over the past decade, Turkishcompanies have run up foreign cur-rency debt at a pace second only to thatof theirpeers inChina.

According to Turkey’s central bank,Turkish companies had foreign cur-rency liabilities of about $210bn at theend of September, the latest month forwhich data are available. “The problemis, it keeps getting worse,” says AtillaYesilada of Istanbul Analytics, a consul-tancy.“Theyarestuckonatreadmill.”

The “rollover ratio” for Turkey’s cor-porate sector was more than 160 percent in the first nine months of this year,according to central bank data. In otherwords, for every $100 due, companiesborrowed those $100 again and added

another $60. “They don’t have a choice.If they don’t keep borrowing they will gointobankruptcy,”saysMrYesilada.

It is easy to see how tightening globalcredit conditions could quickly becomecatastrophic for companies in that posi-tion. But two factors suggest that a crisiscanbeavoided,at least forawhile.

One is that the net foreign exchangeliabilities recorded by the central bankmay be overstated. Ozgur Altug, chiefeconomist at BGC Partners in Istanbul,estimates that Turkish companies haveabout $150bn salted away overseas inundeclared deposits and have beenbringing some of this back into thecountry. Such transfers would show upas borrowing from overseas — perhapsaccounting for about 20 per cent of thenewdebt,MrAltugsuggests.

The other mitigating factor is that theshare of foreign debts maturing in 12months or less is close to zero — at just$5m in September, according to the cen-tralbank.Manybanks, though,areknownto date loans at just a few days over a yearto avoid the short-term label, so this maybe largely a false assurance. However thedebt is measured, says Mr Altug, this“doesn’t mean [currency weakness] won’thit their income statements. There willdefinitelybeanimpact.”

The difficulty for investors is to gaugethe damage likely to be caused by cur-

rency weakness and falling corporateearnings and when, or indeed if, it willbecomecritical.

The challenge for Turkish companiesis how to generate enough foreign cur-rency to meet their repayments. Thereare three ways of doing that: as export-ers,asmembersof thetourismindustry,or as participants in the domestic econ-omy who can make enough lira to buytheforeignexchangetheyneed.

All three sources of income are understress. Exports, which were growing at10 to 15 per cent a year for most of thiscentury, have collapsed over the pasttwo years. Exporters also face an addi-tional currency mismatch: about 60 percent of their foreign debts are denomi-nated in dollars, while the dollar shareof export receipts is only 40 per cent,accordingtoInanDemirofNomura.

“In the Trumpflation world, Turkeywill be in the unenviable position of gen-eratingexportrevenues inothercurren-cies and trying to service dollar-denom-inateddebt,”hesays.

Revenues from tourism have also col-lapsed. As Moody’s Investors Servicenoted when it downgraded the countryto junk in September, income fromtourism fell by nearly 30 per cent in thefirst half of this year from a year earlier,largely as a result of terrorist attacksand of sanctions imposed by Russia last

year after Turkey shot down a Russianmilitary jet.

Moody’s noted: “While the removal ofRussian sanctions is likely to providesome support to the [tourism] sector,full normalisation will be delayed aslong as political and security risksremainelevated.”

As for those indebted companies rely-ing on the domestic market, growth isnot running quickly enough. The econ-omy will grow by about 3 per cent thisyear, far short of the rates Turkey hasachieved this century and of the growthneededtomeet foreignobligations.

Some analysts warn that the moneyborrowed overseas by Turkish compa-nies has not been put to the best use. Had enough of it gone into investmentto boost productivity, things would bedifferent. But too much, critics say, hasgone into Turkey’s money markets,where interest rates are much higherthan the rates borrowers pay on over-seasmarkets.

Michael Harris, an analyst at Renais-sance Capital, says most companiesshould be able to adjust to rising financ-ing costs by raising prices or cuttingcosts, for instance, inheadcount.

But there are limits: “If the lira keepsweakening, the recessionary cost cutswill intensify, giving more reason toworry,”hesays.

Companiesloaded withforeign debtfear rate risesDebt High levels of borrowing are unsustainable,write Jonathan Wheatley and Mehul Srivastava

Turkey’s corporate debt bulge: second only to China’s

Source: Institute of International Finance

Percentage point change in non-financial sector corporate debt to GDP (2005-2015)

-20 0 20 40 60 80

China

Turkey

Russia

Korea

Brazil

Poland

Hungary

India

Mexico

South Africa

Indonesia

Czech Republic

Malaysia

Thailand

Argentina

Much of Europe is mourning a USpresidential election that hascatapulted real-estate mogul DonaldTrump into position as possibly theworld’s most powerful person.

In contrast, Ankara is rejoicing:President Recep Tayyip Erdogan andhis government have made it clear thatthey welcome the result — not onlybecause they think Mr Trump is likelyto upset US power structures, but alsobecause his rival, Hillary Clinton, haddeclared her intention of armingSyrian Kurds, seen as a hostile force bythe government.

Mrs Clinton was also alleged to havereceived campaign contributions fromthe network of the exiled clericFethullah Gulen, accused by MrErdogan of orchestrating the failedcoup attempt in July.

Ankara’s glee is misplaced, however,mainly because the implications of aTrump presidency are likely to be direfor the Turkish economy. Turkey hasachieved average annual growth ratesof about 3 to 3.5 per cent since theonset of the global financial crisis in2007, but its growth has been lowquality in at least three senses.

First, in contrast to a period between2002 and 2006, when productivitygrowth was at 6 per cent per annum,there has been almost none since. Thisimplies that there have been noimprovements in how technology isbeing used or in how labour andphysical capital are being allocated.

Second, the growth has been fuellednot by investment but by consumption,fed by an unsustainable rise in privatecredit, which has increased fromaround 30 per cent of GDP before 2007to almost 80 per cent now. Such rapidcredit growth in emerging economies isoften the harbinger of a loomingeconomic crisis.

Finally, economic institutions havebeen weakened since 2007. A range ofinstitutional reforms — such asincreasing transparency ingovernment, limiting corruption,empowering independent agencies,and introducing a rule-based

decision-making framework — havebeen all but reversed. Instead, publicperceptions of corruption have risenand political meddling in economicaffairs has become commonplace.

Despite its low quality, however,Turkish growth has been resilient. Onereason for this stands above all else: theabundant global liquidity that has beencreated in part by ultra-low worldinterest rates courtesy of the USFederal Reserve and, to a lesser extent,the European Central Bank.

But these conditions seem likely tochange under President Trump. Twopillars of his economic policy areexpected to be massive tax cuts andinfrastructure spending, which themarkets have already begun pricing in.

This re-run of Reaganomics willincrease US fiscal deficits and debt andmay push up US inflation —developments unlikely to leave the Fedwith any other option than raising thefederal funds rate relatively quickly. Asinterest rates increase, the global ordollar liquidity glut will dry up.

Emerging economies in general, andTurkey in particular, have little time toadjust to such a shift in the globalenvironment. Time is running out forthe Turkish economy for other reasons

too. Economic growth had begun toslow even before the coup attempt,increasing uncertainty for foreigninvestors.

The latest indicators suggest theeconomy has contracted in the thirdquarter of 2016, probably leavingTurkey with meagre growth of about 1per cent year on year — the lowest levelin almost a decade. Meanwhile, theunemployment rate has risen by 1.5percentage points to 11.4 per cent overthe past four months.

Turkey shares another trait withsome of its fellow emerging economies:it has a limited capacity for enactingcountercyclical policy to combat asharp slowdown. The weakness of thelira (which has lost some 15 per cent ina matter of weeks); the Turkish centralbank’s aggressive rate cutting sinceMarch (with the exception of themodest increases of last week); a largeexternal financing requirementamounting to almost 30 per cent ofGDP, due to the stubbornly highcurrent account deficit and short-termdebt obligations; and limited centralbank reserves leave little room foraction on monetary policy.

On the fiscal side, Turkey has somebreathing space, thanks to relativelylow government debt-to-GDP ratios(around 35 per cent) and moderateheadline deficits (around 1.5 to 2 percent), but the underlying situation is alot weaker than it first appears, withprimary expenditure growth visiblyoutpacing tax revenue growth.

It is not too late to change course.Growth in the aftermath of Turkey’seconomic crisis in 2001 showed howeven modest attempts towards a moreinclusive economy can spearhead rapidand relatively high-quality growth.Nothing precludes a re-run of thatexperience — except Turkish politics.

An economic revamp requires hardpolitical choices — restarting theprocess of economic reforms, reversingthe control of the government over thejudiciary and economic agencies, andstarting a rapprochement with Europeand the US. This is a tall order, but onethat is urgently needed if Turkey is towithstand the wild and unpredictablewinds of a new Trumpian world.

Daron Acemoglu is the Elizabeth andJames Killian professor of economics at theMassachusetts Institute of Technology;Murat Ucer is Turkey adviser atGlobalSource Partners.

Could Trump trample growthin an emerging economy?

COMMENT

Daron Acemogluand Murat Ucer

Trump Towers in Istanbul

‘Ankara’s glee is misplaced.The implications of aTrump presidency arelikely to be dire’

Businesses investing in Turkey’s realeconomy often say that the trick is tolook past the turmoil of geopolitics andfocus on the potential of the country’syoung,consumption-drivenmarket.

But investors in the stock marketseem to say the opposite: never mindthe fundamentals, watch the politicalrisk, is theapparentmessage.

Despite a steady and impressive risein earnings per share (in contrast to analmost mirror-image fall in EPS foremerging markets as a whole over thepast five years) Turkish stocks haveconsistently underperformed theirpeers. They currently trade at a 35 percent discount to the benchmark MSCIEmergingMarketequities index.

“Turkey is probably the emergingmarket with the highest rate of earningsgrowth and yet the market is derating[falling in price],” says Emre Akcak-mak, portfolio adviser at East Capital,an emerging and frontier market assetmanager. “This tells us a lot. There is alotofpolitical riskpremium.”

East Capital is a long-term investor inTurkish equities and Mr Akcakmak hasbeen looking for bargains in the after-math of July’s failed coup attempt. Valu-ations were already so low they did nothave much further to fall and buyingopportunitieshavebeenlimited.

Thefact thatpricesdidnot fall furtherafter the coup attempt underlines theresilience of asset prices to shocks. Thissupports the view that most foreigninvestors in Turkish portfolio assets areexperienced Turkey hands who havebeen watching the market for years andarehardtoscare.

In spite of the turbulent events of thisyear, foreign investors have shownsome appetite for Turkish risk. Centralbank data show $4.3bn flowing intoTurkish portfolio assets this year, with$1.6bn going to equities and $2.7bn todebt securities. This compares with

combined inflows of less than $1.6bn forthewholeof2015.

Serra Akcaoglu, chief executive of Cit-ibank in Turkey, says this is evidence ofconfidence in the market. “Turkey doesgivepositive interestrates,”shesays.

But others say foreign investors havebeen driven to Turkey, and its fellowemerging markets, by the dearth ofreturnsavailableelsewhere.

“The starting point has to be globalliquidity conditions,” says Inan Demir ofNomura in London. “If global condi-tions weaken, Turkey underperforms inbothabsoluteandrelativeterms.”

Indeed, as asset managers piled intosafer assets — loading up on the yen andgold — they sold nearly $1bn in Turkishsecurities in the week of the US election,accordingtothecentralbank.

Years of loose monetary policy atwestern central banks have been sup-portive for emerging market assets. Thespread this year of zero and negativeyields offered by European and othergovernment bonds has driven someinvestors to take risks they would previ-ouslyhaveavoided.

But with US interest rates expected torise — especially if president-elect Don-ald Trumpreflates the US economy —flows to EM assets could well go intoreverse. This would be particularlydamaging for EM fixed income assets,which have ridden on a global fixedincomerallymanybelieve isending.

Added to this are Turkey’s own politi-cal and economic risks. Despite lastweek’s modest interest rate rise fromthe central bank, short-term rates forfixed income investors are close to zero,saysMrDemir.

“It is hard to argue that this is ade-quate reward for the risks investors aretaking,”hesays.

Watch the risk, notthe fundamentalsPortfolio investment

Experienced investors areproving hard to scare,reports Jonathan Wheatley

Despite a rise in earningsper share, Turkish stockshave underperformed theirpeers consistently