FT SPECIAL REPORT

Investing in Turkeywww.ft.com/reports | @ftreportsFriday November 28 2014

Inside

‘Quick, aggressive’reform requiredEconomic progress heldback by unemploymentand the gender pay gapPage 2

President moves tocentralise powerErdogan is no longerregarded abroad as achampion of democracyPage 3

Build at all costs$600m presidentialpalace is emblematicof a construction frenzynow running into troublePage 4

A dismal recordHundreds of minershave been killed inindustrial accidents.Will policy makers act?Page 4

On FT.comCase study: how a lentilexporter made billionsft.com/reports

Turkey’s inability to generateconsistently high, long-term foreigndirect investment (FDI) highlights thecountry’s growing dependence onvolatile short-term capital flows tomeet its increasing debt burden.

Without more FDI, Turkey has littleammunition to offset the stress on itsfinancial system if that short-termcapital leaves rapidly when low globalinterest rates start to rise.

A recent report by Fitch Ratingsindicates the risk that Turkey faces.“Turkey’s external finances haveweakened in recent years, as foreigndebt has increased and become moreshort-term, while foreign assets haveexpanded only moderately,” the reportsays. “This has resulted in a significantrise in the country’s net external debtand a deterioration in the internationalliquidity position.”

Analysts estimate that, given thepredominantly short-term structure ofits debt, Turkey needs at least $150bnof foreign inflows every year to servicesovereign, banking-sector andcorporate debt and to cover the currentaccount deficit.

An emerging-market bond dealer inLondon sums up Turkey’s dilemma.“For the time being, we remaininvested in Turkish debt. With globalinterest rates so low, you can still makemoney borrowing dollars and buyingthat debt. But the trend in Turkishdebt is worrying, and my finger is onthe trigger. At the first whiff of change,I am out of there.”

One of the puzzling features of theTurkish economy over the past severalyears has been that slowdown incritical FDI, in what has been one of thestronger emerging markets.

In 2002, FDI stood at just $570m,rising sharply in subsequent years. Butdespite the seemingly obviousattractions of a large population on theedge of Europe, increasing purchasingpower and an entrepreneurial culture,the gross amount of FDI has declined,from a high of more than $19bn in2007 to just over $10bn in 2013.

FDI from January to September 2014declined to $6.6bn, compared with$7.1bn for the same period last year.

The positive impact of these FDIflows on the balance of payments hasbeen reduced further by increasedinvestment by Turkish companiesoutside Turkey, as they adapt rapidlyto globalisation.

In 2002, Turkish companies investeda mere $251m outside their owncountry. By 2013 this had risen to$3.3bn. This amount increased againin the first eight months of 2014, whenoutward investment flows reached$4.1bn, compared with $1.8bn for thesame period in 2013.

A large portion of the outflow thisyear consisted of the $1.5bn thatTurkiye Petrolleri Anonim Ortaklıgı(Tpao), the Turkish petroleumcompany, paid for a 10 per cent sharein the Shah Deniz gas project inAzerbaijan’s section of the Caspian Sea.

Atilla Yesilada, a political andeconomic commentator, offers severalreasons for the comparatively lowamounts of FDI. “First, there is theglobal aversion to risk. On top of this,the traditional European countriesthat would invest in Turkey are havingtheir own problems. Many companiesare struggling with the slowdown inEurope and are in no shape to look atinvesting in Turkey.

“Also, who is going to finance theseinvestments? European banks are notin great shape. The second thing is thatmost Turkish companies . . . aresimply too small to attract majorinvestment flows. Other thaninfrastructure projects, there is notmuch left to invest in.

“And, of course, there is the politicalelement. With [President RecepTayyip] Erdogan acting like a PR agentfor the Muslim Brotherhood, it isunlikely that we will get much morefrom the big investors in Saudi Arabiaor the UAE. And China’s concernsabout its own restive Muslim Uyghurpopulation in Xinjiang may make itreluctant to invest in a country seen tobe friendly to the Uighurs.”

Despite Turkey’s push for more Arabinvestment, Central Bank of Turkeystatistics show that European countriescontinue to contribute more than 60per cent of FDI in Turkey. With theexception of a big investment from

Saudi Arabia to buy Turk Telekomseveral years ago, the biggest non-European investor in Turkey in recentyears has been Azerbaijan.

The State Oil Company of Azerbaijan(Socar) is building a $5.5bn refinery onthe Aegean coast north of Izmir.Turkey in turn has invested more than$3bn in Azerbaijan since 2010.

Some observers point toinfrastructure projects, especially inthe energy sector, and privatisations ascatalysts to attract further FDI.

“The Turkish ministry of energyhas done well to streamline and clarifythe procedures for investing in energy,”says James Preston, an independentinvestment banker specialising insoutheast European infrastructure.

“The [ministry is] also offeringhealthy incentives for generation fromrenewable sources. This could beattractive for foreign investors in thenext few years,” he adds.

The list of proposed privatisations islong, and includes all or portions of theIstanbul stock exchange; Halk Sigortaand Halk Emeklilik, the insurance andprivate pensions companies; Igdas, thenatural gas distribution company;Botas, the petroleum and natural gaspipeline and trading company; tollroads and bridges; horseracing andSpor Toto, a lotto company.

While privatisations have investmentpotential, there is no guaranteethat they will quickly attract fundsto make a difference to the currentaccount deficit. The winners couldwell be domestic companies thatwould simply be recycling domesticfunds with no significant positiveimpact on the country’s balance ofpayments.

For example, the recent winning bidof $2.76bn for the rights to operateMilli Piyango, the national lottery, for10 years, was won by a consortium oftwo Turkish companies providing theinvestment and a US company actingas a service provider.

Another problem is that winning abid is just the first step in a lengthyadministrative and judicial processbefore funds are received.

Sharply increasing long-term foreigndirect investment could ease Turkey’sfinancing problems. But the country isfacing strong headwinds in its efforts toattract that investment.

The writer is a participant in a businessproject seeking to raise funds for ageothermal project in Turkey’s Aegeanregion

Foreign capital could be the answer todebtwoes, but headwinds are strongCOMMENT

DavidEdgerly

R ecep Tayyip Erdogan, Tur-key’s president, may lookback on 2014 as a pivotalyear.In the past 12 months, he

has prevailed over Islamic allies-turned-enemies, won two national votes – thesecond of which made him the country’sfirst directly elected head of state – andinaugurateda$600m,1,000-roompres-identialpalace.

But if the past year has brought per-sonal triumphs at home for the formerprime minister, sometimes those sametriumphs have tarnished the country’sreputationabroad.

Ankara’s international image hasbeen damaged by corruption investiga-tions – since quashed – into MrErdogan’s circles of intimates; by hisattempts to ban Twitter and YouTube;and by international calls for Turkey totake action against its new jihadi neigh-bours, the Islamic State of Iraq and theLevant, thegroupknownasIsis.

This fall from grace comes at a time offebrile markets and expectations oftesting times for emerging economies,andforcountriessuchasTurkey.

The country, which depends on highlevels of foreign finance, is goingthrough a time of transition. Electionsnext year could further determine thescope of Mr Erdogan’s power, whileexpected US interest rate rises mayreduce the volume of foreign fundsavailable foremergingmarkets.

A key question is how Turkey’stumultuous political scene affects itseconomic prospects. That comes downto the extent of the authority wielded byMrErdoganandtheruleof law.

In the medium term, the economicpolicies Mr Erdogan supports – andwhether those policies are financiallyliterate – will help decide to what extentTurkey can continue receiving theforeign financing that underwrites itssubstantialcurrentaccountdeficit.

Alpona Banerji, an analyst at

Moody’s, the rating agency, says: “Theimportant thing to focus on is uncer-tainty about the direction of economicpolicy, especially at a time of low eco-nomicgrowth.”

In the long term, the extent of MrErdogan’s power, and the remainingchecks and balances to it, may have astill more profound impact on the coun-try’sprospects(seepage3).

Robert Burgess, chief emerging mar-kets economist at Deutsche Bank inLondon, suggests that unless Turkey’s

institutions are strengthened its poten-tialgrowthmaybeheldback.

“Only five countries have been able toachieve higher income levels than Tur-key with weaker institutions,” he says,referring to Bahrain, Kazakhstan,Russia, Saudi Arabia and Venezuela, asranked by World Bank governance indi-cators.“Allareoilproducers.”

But high-profile foreign direct invest-ments are still being made in Turkeyand companies are continuing toexpand abroad. This month, Yildiz

Checks on power hold key to growthConcerns are rising overthe president’s influenceand the viability ofeconomic policies,writesDaniel Dombey

Sealed: gates to Turkey’s new, $600m presidential palace, the residence inaugurated by President Erdogan – Getty

Holding, Turkey’s biggest food com-pany, took control of Britain’s UnitedBiscuits for £2bn. BBVA, the Spanishbank, also this month announced one ofthe biggest foreign direct investments inthe country in recent years, agreeing topay €2bn to increase its stake in GarantiBankfrom25to40percent.

The further investment in Turkey’sbiggest bank by market capitalisation isa sign of confidence by BBVA, whichexpects Turkey to grow by 4.6 per cent ayear over the next decade (see page 4),wellaheadofother forecasts.

The Spanish bank is far from alone inits belief in Turkey. The European Bankfor Reconstruction and Developmenthas €1.4bn a year to invest in the coun-try and recently paid €125m for a 15 percent stake in Pasabahce, a glass table-ware manufacturer. In November,Tofas, a joint venture between Italiancarmaker Fiat and Koc Holding, Tur-key’s biggest conglomerate, unveiled a$520m investment to produce new linesofcarsat itsplantatBursa.

Mustafa Koc, Koc Holding’s chair-man, said his group – which alsorecently opened a $511m plant for itsseparate joint venture with Ford – wasgoing through the “biggest organicinvestment period” in its history. Hepledged support for the goal of turningTurkey into one of the 10 biggest econo-mies intheworldby2023.

In reality Turkey’s economic pros-pects are less spectacular. Few econo-mists believe the country can catapultfrombeingtheworld’s17thbiggestecon-omy into the top 10 within nine years. InNovember, Ahmet Davutoglu, primeminister, unveiled a goal of increasinggross domestic product from $820bn in2013 to $1.3tn in 2018. But at best thisstrains credulity; at worst it is an error,

Continuedonpage3

Borsa Istanbul,Turkey’s state-runstock exchange, isamong assets on alist of proposedprivatisations

2 FINANCIAL TIMES Friday 28 November 2014

Investing in Turkey

Turkey’s challenge in numbers

InflationAnnual % change in CPI

2002 04 06 08 10 12 14

0

10

20

30

40

GDP growth

Sources: Central Bank of the Republic of Turkey; Undersecretariat of Treasury; IMF; Thomson Reuters Datastream FT graphicPhoto: Dreamstime** Forecast

Annual % change in real GDP

-5

0

5

10

2002 04 06 08 10 12 14**

JulMay JunAprMarFebJan Aug Sep

Balance of paymentsCurrent account Current account

2002-17,$bn

Jan-Sep, 2014

-$30.9bn

Jan-Sep, 2013

-$49.2bn

2002 10 13* 1 7

-80

-70

-60

-50

-40

-30

-20

-10

0

Foreign direct investments in Turkey Residents’ FDI abroadAll sectors, 2014* ($m) All sectors, Jan-SepAll sectors, 2002-13 ($bn)

* Provisional

0

5

10

15

20

2002 04 06 08 10 13* 2002 04 06 08 10 13*

0

200

400

600

800

1000

1200

Jan 2014 Sep

2014*

$6.6bn

2013*

$7.1bn

Total ($bn)

0

1

2

3

4

5

2014 onwar ds is projection byUndersecretariat of Treasury

-$2.3bn

-$3.6bn

-$4.1bn

-$4.9bn

-$3.3bn

-$5.0bn

-$2.2bn

-$3.3bn

-$2.1bn

A s a tumultuous year drawstoaclose, theTurkishecon-omy is enjoying a momentof respite. But for all itsstrengths, Turkey remains

one of the emerging markets mostexposed to shifts in global sentiment, inparticularUSinterestraterises.

Without a change in policies, eco-nomic performance is likely to beweaker than in the recent past, theInternational Monetary Fund warned inSeptember. The country risks a “mid-dle-income trap” it said, as well as itsexposure to a possible “sharp decreaseincapital inflowstoemergingmarkets”.

Recent economic developments havefavoured Turkey, notably expectationsthat the US Federal Reserve will wait toincrease rates, a move that could reducethe volume of funds ploughed intoemerging markets. Turkey, a big energyimporter, has also benefited from a glo-bal fall inoilprices.

Banks and corporates are rolling overtheir debts, and some are increasingthem. In a volatile year that began withpressure on Turkish assets across theboard and in which the lira remainsmuch lower against the dollar thanbefore, stocks recovered strongly afterPresident Recep Tayyip Erdogan tri-umphedin localelections inMarch.

With Russia hit by sanctions andSouth Africa and Brazil stricken byproblems of their own, Turkey remainsan emerging market that portfolioinvestors finddifficult toavoid.

Erdem Basci, central bank governor,exulted in October that the country’sexpected growth rate of 3.3 per cent thisyear – helped by improved exports andthe revival of domestic demand – was“probablythehighest inEurope”.

But Mr Basci and others in govern-ment acknowledge that without struc-tural reforms that are unlikely beforeelections next year, the economy is gov-erned by “speed limits” that hold backthe rate at which it can grow without thecurrentaccountdeficitballooning.

At present, 27 per cent of young

people are not in work, education ortraining, although previously the levelwas much higher. Turkey is 125th of 142countries on the World EconomicForum’s Gender Gap Index. Low domes-tic savings mean the country needsmorethan$200bnof foreign financingayear – more than a quarter of grossdomestic product – to maintain the cur-rentpaceofgrowth.

“If we can . . . quickly and aggres-sively push the reform agenda, Turkey’s

story will be a very strong one,” MehmetSimsek, finance minister, told the FT inSeptember.

Assuming that comes to pass, MrBasci argues, the economy could returnto levels of 5 per cent growth by 2017.But such reforms – if they do emerge –might not come in time to rein in Tur-key’s financing needs if the US raisesinterestratesnextyear.

In the short term, Mr Basci seeks toholdthecurrentaccountdeficit incheckthrough “macroprudential” measuresthat dissuade banks from rapidlyincreasing the amount of money theylend,particularly toconsumers.

At the same time, the central bank isseeking to limit inflation by maintaininga “flat yield curve” – ensuring that theshorter-term rates at which it lendsfundsarebroadly in linewiththe longer-termratesdeterminedbythemarket.

Other economists say the rise in con-sumer prices indicates that the centralbank is not seriously targeting inflationand has instead partially acceded topressure from Mr Erdogan, who insists,in defiance of economic theory, thathigh interestratescause inflation.

An allied concern is that the Turkisheconomy–as it is currentlymanaged– ispeculiarlyvulnerable toshocks.

“Turkey is still comfortably amongthe emerging markets that are the mostsensitive to global appetite for risk,”says Robert Burgess, chief emergingmarkets economist at Deutsche Bank inLondon. “It’s almost by design; that iswhat trying to maintain a flat yieldcurvemeans.”

‘Quick, aggressive’ reformneeded to boost growthEconomyLowdomesticsavings, unemploymentand the gender pay gaphold the country back,reportsDaniel Dombey

Turkey remains anemergingmarket thatinvestors find hard to avoid

Cash flow for now: but consumers could soon find lending restricted – Bloomberg

Friday 28 November 2014 FINANCIAL TIMES 3

Investing in Turkey

Contributors

Daniel DombeyTurkey correspondent

Delphine StraussCurrencies and former Turkeycorrespondent

Piotr Zalewski, Andrew FinkelFreelance writers

David EdgerlyFreelance writer and formerfund manager

Christopher CampbellGraphic designer

Helen BarrettCommissioning editor

Steven BirdDesigner

Andy MearsPicture Editor

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Global investors have grappled with thenotion of banks being “too big to fail”,but in Turkey they may have to makesenseofabanktootrivial tomatter.

In recent months, Turkish regulatorshave been suspected, not of propping upwounded leviathans – analysts agree thefinancial sector is in good shape – but ofputting pressure on a small financehouse caught in a political dispute withthegovernment.

Bank Asya, a “non-interest” Islamiclending institution, is associated withthe Gulen religious movement, whichonce had highly placed supporters inthe police and judiciary. The govern-mentblamesthosesupporters for inves-tigations in December 2013 into high-level corruption within the ruling Jus-ticeandDevelopment(AK)party.

Since then, the bank, which accountsfor less than2percentofbankingassets,has suffered. Funds have been with-drawn by businesses connected to thestate, including Turkish Airlines; thebank’s standard agreement to collecttaxes has been cancelled and permis-sion to issue bonds refused. At one pointPrime Minister (now President)Erdogan declared Asya “already bank-rupt”, raising doubts about his respectfor Turkey’s strict banking rules by risk-ingarunondeposits.

In September, public trading in BankAsya was suspended three times – halt-ing what was at the time a recovery in itsshare price. The head of the exchange,Borsa Istanbul, denied the suspensionswerepoliticallymotivated.

President Erdogan made no apologiesfor ordering an audit. “The bank’s cur-rent assets had grown eightfold and itsdeposits had grown sixfold over the past12years.There isnoprimeministerwhowould sit back and do nothing,” he toldTurkey’s business confederation. Hesaid the move was to prevent a return toa time when Turkish banks failed forbeing inadequatelycapitalised.

But how much has the incident, andothers like it, undermined confidence intheTurkishbusinessenvironment?

“There has been a lot of state inter-vention in the economy that looks polit-ically – not technically – motivated,”says Izak Atiyas, professor of economics

at Istanbul’s Sabanci University. “Inevi-tably, this means investors are going tolook twice before jumping in. They willshorten their horizon and require ahigherreturn,”hesays.

The European Commission’s 2014Turkey Progress Report finds theDecember 2013 allegations of corrup-tion in the AK have reduced transpar-ency. It states “perceptions of politicallymotivated decisions increased” afterthe“reshufflingof the[banking]regula-tor’s seniormanagement”.

Some say these institutional ques-tions would have been resolved hadTurkey made greater progress in itsapplicationformembershipof theEU.

“The rules that apply in Europe onlypartly apply in Turkey,” says MehmetGerz, general manager of Ata AssetManagement inIstanbul.

Turkish shares trade at a 25 per centdiscount to those in Poland – eventhough Turkey has stronger budget anddebt figures. “The difference is EUmembership,”MrGerzadds.

To fund managers used to riding thetailwinds of the fluctuating interest andexchange rates of emerging markets,the Bank Asya saga is an example ofarbitrary government that they are pre-pared to overlook. For long-term anddirect investors, it is another backwardstep from market-oriented reforms thatthe AK party brought in when it came topowerin2002.

Economic and institutional transfor-mation between 2003 and 2007 wasresponsible for average real productiv-ity growth (according to OECD figures)of 8 per cent a year. And though Turkeywas quick off the mark after the Leh-man crisis, averaging close to 9 per centgrowth in 2010-2011, this was almostentirely consumer-led. Real productiv-ity growth between 2008-2013 has beenalmostzero.

Bank Asya has remained liquid butonlybyhalving itsdepositsovertheyear(according to third-quarter results) andsheddingnearlyathirdof itsworkforce.

“International investors have diffi-culty in understanding the situation,”the bank says. “This is a well regulatedindustry. We hope investors don’t getthe wrong picture . . . but, God forbid, itisapossibility.”

Islamic bank under pressure asstate businesses withdraw fundsRegulation

A government-ordered auditof Bank Asya appearsto many to have beenpolitically motivated,reports Andrew Finkel

Funds have beenwithdrawn fromBank Asya bybusinessesconnected tothe state

F or much of his time in office,Recep Tayyip Erdogan hasbeen regarded internationallyas a leader who has battled fordemocracy against Turkey’s

military-backedoldorder.Mr Erdogan, who served as prime

minister for more than a decade until hewas elected president in August, and hisAK party overcame a series of threats totheir rule – including an ultimatum bythe generals, a tussle over the presi-dency and a court case that almostcloseddowntheparty.

But his image abroad has changed inrecent months, particularly since a gov-ernment clampdown on mass protestslast year. He is now increasinglyregarded as an authoritarian who issteadilycentralisingpower.

The president’s supporters complainthat such an image is a caricature, prop-agated after a string of defeats by MrErdogan’s political opponents and theirallies abroad. But some of his criticsmaintain that he was never a championofdemocracy.

What is indisputable is that MrErdogan has a further move in mind. Hewants to turn Turkey’s parliamentarysystem into a presidential one – a cam-paign that has taken on still greaterimportance now that he has becomeheadofstate.

Mr Erdogan has won nine successivenational votes – a record with few paral-lels anywhere. If the AK party deliversone more convincing win in generalelections next year, it could secure thetwo-thirds parliamentary majority it

needs to change the constitution inaccordancewithhiswishes.

The government takes it as given thatit will once again rout – and perhapseven eradicate – its opponents, who areassociated by many voters with the fail-uresof thepast.

“New Turkey’s genuine oppositionwill not emerge until we see the last ofthe old Turkey and the discourse andproponents of the establishment com-pletely disappear,” wrote Taha Ozhan,an adviser to Ahmet Davutoglu, theprimeminister, inSeptember.

Yet a two-thirds majority could be anoverly optimistic ambition. Mr Erdoganscored about 52 per cent in the excep-tional circumstances of August’s three-candidatepresidential race.

Local elections in March showed AKsupport edging down from the levels atthe last parliamentary elections in 2011.That year, despite gaining almost 50 percent of the vote, it failed to win two-thirdsof theseats.

Since 2011, the economy has slowed,much of the broader region is in turmoiland Mr Davutoglu, who is also the newparty leader, is not as tried and tested atwinningvotesasMrErdogan.

The president’s supremacy lies some-where between de facto and de jure.“Turkey is already being run out of thepresidential palace,” says Kadri Gursel,a prominent Turkish commentator.“Erdogan would die for a new constitu-tion–hewould like tomakehispersonalregime a constitutional one, but I don’tthinkhecandoit.”

The current Turkish constitution

requires the president to sever ties withhis or her former party, to implementthe constitution and to represent “theunityof thenation”.

But Mr Erdogan, as the leader whodelivered economic growth, better serv-ices and the empowerment of socialconservatives, is unchallengeable in theloyaltiesofmanyAKpartyvoters.

Privately, some AK party supporterssuggest Mr Erdogan will still havenfluence over the party list of candi-dates for the new parliament, and couldinformally campaign for it before theelections. Despite his elevation, MrErdogan continues to hold massmeetings and appears intimatelyinvolved in decisions over governmentpersonnel.

The president has laid out the path forMr Davutoglu’s government. He hasinstructed it to prioritise the battleagainst the movement of FethullahGulen, a US-based former ally with fol-lowers inmanystate institutions,aswellas efforts to end the country’s Kurdishconflict, in which about 40,000peoplehavedied.

The drive to shift Gulenists from sen-ior posts in the judiciary and the

bureaucracy continues, and the govern-ment has piled pressure on a Gulenistbank(see storybelow).

Thestateof theKurdishpeaceprocessis less certain. After a year and a half ofcalm, killings have resumed, with thegovernment and the outlawed Kurdis-tanWorkersparty(PKK),accusingeachotherofdraggingtheir feet.

Many Kurds are furious at what theysee as Ankara’s ambivalence towardsthe jihadi fighters of the Islamic State ofIraqandtheLevant,knownasIsis, fight-ing the PKK’s Kurdish sister organisa-tion inSyria.

Mr Gursel says the situation demon-strates how the Kurdish disputecannot be dealt with in isolation from aTurkish political scene in whichMr Erdogan is loath to surrender power,or from the broader regional context.The PKK’s Syrian affiliate is now effec-tively allied with the US in the battleagainst Isis.

Hugh Pope, of the International CrisisGroup, an NGO, likens the currentimpasse to Turkey’s stalled bid to jointhe EU: “Both sides are playing for time,undermining the process, but neitherwants to . . . pull theplug.”

Upheaval loomsas Erdoganattempts tocentralise rulePoliticsThe president is no longer regarded abroadas a champion of democracy, writesDaniel Dombey

Time forreflection:PresidentErdoganGetty

‘Turkey isalreadybeing runout of thepresidentialpalace –Erdoganwould diefor a newconstitution’

because it could require annual growthratesofupto15percent.

By contrast, the government expects3.3 per cent growth this year and 4 percent next year. Against such a backdrop,Mr Erdogan, whose chief economicadviser, Yigit Bulut, is known for theo-ries about an “interest rate lobby” benton Turkey’s downfall, and about thesupposed telekinetic powers of the pres-ident’s enemies, has called for the cen-tral bank to slash rates in order tounleashgrowth.

Others in the government – notablyAli Babacan, the deputy prime ministerresponsible for the economy – empha-sisestructuralreformandtheruleof law.Mr Erdogan champions construction asan engine of economic growth (see page4), while Mr Babacan says constructionalready accounts for too much of Tur-key’seconomicactivity.

At the same time, foreign directinvestmenthasalmosthalvedfromanet$19bn in 2007 to $10bn last year. Thathas left the country reliant on bank andcorporate borrowing to finance much ofthecurrentaccountdeficit.

Some of the most notable deals thisyear have been exits rather than entries,sometimes valuing investments at lessinhardcurrencytermsthantheamountfor which they were acquired. KKR, theUS private equity group, offloaded itsTurkish ferry business for an estimated€700m, while BC Partners has been intalks to halve its 80.5 per cent stake inMigros, thesupermarketchain.

The fundamental strengths of Turkeyremain: its enviable geographic positionand large internal market. But invest-ment is inhibited by travails in the EU,by far Turkey’s biggest direct investor,and concerns about the country itself.Mr Erdogan’s ties with favoured compa-nies remain under scrutiny. He nolonger formally leads the government,but it remains in his shadow. Much maydepend on whether his allies win a suffi-cient majority in next year’s election tosetupaformalpresidential system.

Continued frompage1

Checks onpower holdthe key togrowth

4 FINANCIAL TIMES Friday 28 November 2014

Investing in Turkey

S hould BBVA’s decision to pay$2bn for a bigger, controllingstake in Turkey’s GarantiBank be viewed as a vote ofconfidence in the country’s

long-termgrowthpotential?Or should the decision to sell by

Dogus, the family conglomerate thatbuilt Garanti over decades, be a warningthat Turkish banks may struggle toimprove on their previous perform-ance?

Both interpretations of the agreementreached last month between the Span-ish banking group and the Turkish fam-ilyconglomeratehavesomefoundation.

Well capitalised and competitive,Turkish banks proved their resilienceduring the global financial crisis, andhave long been viewed by equity inves-tors as a proxy for betting on an econ-omy propelled by rapid populationgrowth, rising consumption and ambi-tious infrastructure investments.

Foreign banks have also been keen togain a foothold in the market. Italy’sIntesa Sanpaolo, the Dutch lenderRabobank and Bank of Tokyo-Mitsubi-shi have all won licences to operate inthe past two years, while smaller Turk-ish banks have been snapped up. Rus-sia’s Sberbank bought DenizBank in2012, and the Industrial and Commer-cial Bank of China is finalising its acqui-sitionofTekstilbank.

But there are pressures on the sector.Last year, Turkish banks were hit hardin the “taper tantrum” (the turbulenceafter the US Federal Reserve reduced itsbondpurchases) thatafflictedemergingmarkets, with Turkey seen as one of thecountries most exposed to rising USinterestrates.

Since then, Turkish banks have beenbuffeted by political turbulence and atougher economic climate. A sharp risein interest rates in January – an emer-gency measure to stem a slide in thelira–ate intomargins.

Regulators also brought in meas-ures designed to curb growth in con-sumer credit, which has outstrippeddeposit growth in recent years,

leaving banks increasingly reliant onshort-term external debt to fund lend-ing.

Meanwhile, slowing economic growthand a steep increase in unemploymenthave led to a marked rise in non-performing loans, especially for creditcards and consumer lending, whichanalysts expect to worsen in comingmonths.

The result has been a sharp fall inprofitability, with the sector’s net earn-ings for the first nine months of 2014down some 5 per cent year-on-year.Return on equity, which averaged 18.5percent inthedecadeto2013,nowaver-ages 13 to 14 per cent across the sector –with inflationclosetodoubledigits.

But some of these pressures may beeasing. Regulatory changes are mostlycomplete and the central bank haseased itsmonetarystance,allowing loangrowthandmarginstostabilise.

Cristina Marzea, an analyst at Bar-clays, the UK bank, says: “The banks areneither profitable enough nor cheapenough to warrant a massive re-rating,but are well supported by macro, resil-ient operational performance and valu-ations.”

Political tensions are likely to rise inthe run-up to next year’s parliamentaryelections, and a key concern forinvestors will be whether the team of

economy chief Ali Babacan and financeminister Mehmet Simsek remains inplace, since they are seen as a check onthe unorthodox economic views ofsome senior figures in the ruling AKparty.

Yigit Bulut, economic adviser to Pres-ident Erdogan, wrote in August that thebanking sector “seems to have beenabandoned to the control and mercy ofbothforeignersand‘foreignerswithin’”.

However, the travails of Bank Asyaaside (see page 3), analysts think the AKparty remains too pragmatic to put theinterestsof largerbanks in jeopardy.

At present, Turkey looks relativelystable compared with emerging marketpeers such as Brazil – whose economicpolicies have yet to take shape afterelections – and Russia, hit by sanctionsandthecollapse incommodityprices.

Turkey,bycontrast, isoneof themainbeneficiaries of the lower oil price,which will help to narrow a persistentcurrent account deficit and bring downinflation.

However, investor sentiment couldswing sharply negative, once US interestrates finally start to rise – and the mainworry for the banking sector is that it isno longer as well cushioned against suchshocksas itwas inthepast.

In September, rating agency Fitchdrew attention to the rapid increase inTurkey’s external debt since the globalfinancial crisis, noting that it had beendriven by a trebling of foreign borrow-ingbybanks,muchof it short-term.

Turkish banks have so far consist-entlyprovedable torollover thesedebtsand raise new funding, but Fitch warnsthat the high proportion of short-termdebt could leave them vulnerable if for-eign currency liquidity dried up instressedmarketconditions.

Istanbul-based analysts are moresanguine about Turkish banks’ abilityto weather tough markets. “This is theenvironment we’re in,” says CanDemiratRenaissanceCapital.

“Real interest rates are lowglobally and there’s not a lot ofgrowth around in deposits to sup-port loan growth. So, you go to for-eign banks for funding; that’s how

the new business modelworks.”

Foreign funds still arrivedespite turbulenceBanking Sector appeals though profitability has fallen, writesDelphine Strauss

Investors will look to see ifAli Babacan remains in his jobas deputy prime minister

In parts of Istanbul, as in most Turkishcities, you can smell the coming of win-ter before you properly feel it. Just as thefirst cold spell arrives, a woolly, sourblanket of smoke, pumped into the airfrom coal-fired furnaces, settles overthecity’spoorneighbourhoods.

Turks are noticeably better off than adecade ago, but with the prospect ofhigh natural gas bills, many still rely oncoal to heat their homes. More than 2mfamilies relyonthestate toprovide it forfree.

Under a programme launched by theruling Justice and Development (AK)party in 2003, a government agencyhands out about 2m tons of coal tounderprivilegedfamilieseachyear.

For a country that depends onimports for roughly 70 per cent of itsrapidly growing energy needs, coalappears to be both part of the solutionandpartof theproblem.

Over the next decade, Turkey’s gov-ernment plans to increase the share ofcoal in electricity production, from 25 to30 per cent. To help meet its goal of totalinstalled capacity of 120,000MWs by2023, it also plans to tap into all thecountry’scoalreserves.

“They plan to mine coal whereverthey can find it,” says Ozgur Gurbuz, anenergy and environment expert. Thedanger, he says, is that this may drive uptherateof fatalities inTurkey’smines.

Between 2007 and 2012, 4.6 minersdied for each million tons produced inTurkey, compared with 0.2 in the US, 1.3in India and 7.4 in China, according to arecent paper by the Economic PolicyResearch Foundation of Turkey(Tepav),anAnkarathink-tank.

This year alone, 301 people died aftera fire broke out in a mine in Soma, nearthe Aegean coast, which produced coalfor state-owned Turkish Coal Enter-prises (TKI). In October, a flood buried

18 workers inside a mine in Ermenek, inthesouth.

The main culprit, says Mr Gurbuz, is aflawed privatisation model. By award-ing licences to mine operators that offerit the highest possible royalty per kW/hour, thestateopensthewayforcompa-nies tosacrificesafety forprofit.

“When you’ve offered the state toomuch money, the only way to makeyour mine profitable is to lower costs, tofind cheap labour, or to force workers toworklongerhours,”hesays.

In 2012, Alp Gurkan, the owner of thefacility where 301 miners died, braggedthat he had cut production costs from$130-$140pertontobelow$24.

Mining companies tend to outsourcesomeoperationstosubcontractors.Thiscomes at the expense of miners’ safetyand also dilutes responsibility, saysGunesAsik,aTepaveconomist.

Turkish officials point towards themines’ management. “The main factorbehind these accidents is [the] lack of ahealth and safety culture,” says KasimOzer, director-general at the ministry of

labour. “It is not important for us if it is apublicorprivatemine.Themost impor-tant point is modernisation and rehabil-itationof themines.”

The government appears to beaddressing the problem. On November12, prime minister Ahmet Davutogluunveiled laws intended to improvesafety at work. Under the proposals,companies found liable for fatal acci-dents would be banned from public ten-ders for two years, while those with norecordofaccidentswouldberewarded.

Mining companies would be obligedto provide workers with life insuranceandinspectionswouldbesteppedup.

Accountability, however, appears tostop at the government’s door. To date,despite energy minister Taner Yildiz’soffer to do so, no cabinet figure hasstepped down in connection with thisyear’sminingdisasters.

Workers pay a deadlyprice for cheap coalMining

Privatisation model isaccused of encouragingsacrifice of safety for profit,writes Piotr Zalewski

New laws areproposed topenalise miningcompanies foundliable for fatalaccidents

In early November, an unusual postingappeared on Craigslist, a popular classi-fied advertising website, alongside aphoto of a sprawling, airport-sized edi-ficecappedwithanOttoman-styleroof.

“Rooms in Recently Built Palace,” itread. “I have just spent TL1.37bn[$616m] building a nice new palace andneedtorentouta fewrooms.”

The advert was obviously bogus. Yetthe property to which it referred, popu-larly known as the Ak Saray, or WhitePalace, a nod to the home of US leadersand the name of the governing JusticeandDevelopmentparty(AKP),wasnot.

An emblem of what Recep TayyipErdogan calls the “New Turkey”, thenew presidential complex, comprising1,000 rooms built over an area of150,000 sq m in Ankara, leaves fewdoubts as to the scale of its tenant’sambitions.

As the latest manifestation of a build-ing frenzythathas transformedmuchofTurkey into a developers’ paradise, italso underscores the faith the country’sgovernment has placed in the construc-tionsector.

By 2023, the centenary of the repub-lic, Mr Erdogan wants gross domesticproduct to reach $2tn, up from $820bnin 2013, implying an average annualgrowth rate of 14 per cent. The AKPgovernment is counting on the buildingindustry to chip in generously. Tomeet the 2023 target, Turkey willneed $700bn worth of new airports,

roads, power plants, rail links and otherinfrastructure, Ali Babacan, deputyprime minister, said this year. An urbanrenewal programme is expected tobring an additional $400bn of invest-ment.

Unlike the new presidential complex,which will cost Turkish taxpayers$610m,according to figuresprovidedbythe finance ministry, money for otherprojects meant to usher in the “NewTurkey”maybeharderto find.

Between 2009 and 2013, as Turkey’seconomy rode high on the back of short-term capital inflows, the constructionsector surged by an average of 12.6 percent, including 18.3 per cent in 2010.Thanks to a slew of government-backedprojects and demand for new housing,growth in the sector is bound to con-tinue, say analysts, but the boomappears to be over. With the amount ofmoney sloshing round in global finan-cial markets diminishing and with aweaker lira raising the costs of borrow-ing abroad, access to capital has growntight, saysUgurGurses,aneconomist.

“This is going to make it difficult forthe private sector to finance someprojects, especially the biggest ones,” hesays. “In terms of being the locomotiveof the economy, the construction andrealestatesectorsare losingpower.”

Although senior government figures,includingMrBabacan,havestressedtheneedforstructural reformsandreducedreliance on construction, an alternativegrowthmodelhasyet tobefound.

“Better housing is needed, but theeconomy needs to be competitive withthe rest of the world – and you can’t dothat by building,” says Nihat BulentGultekin, former head of Turkey’s cen-tral bank, now associate professor offinance at the Wharton School of theUniversityofPennsylvania.

“I don’t see any long-term vision as tohow they’re going to take Turkey to thenext stage, to expand industry, to[transform] it into another [South]Korea,”headds.

The problem with projects such as AkSaray, Mr Gultekin says, is that they sig-nal a vision – and a determination – tobuild at all costs. One of those costs maybe the rule of law. In March, an Ankaracourt ordered all work on the presiden-tial complex to come to a halt, arguing itwas being built on a protected forest.Constructionproceededregardless.

A presidency official, speaking to thestate-run Anadolu news agency,insisted the palace had been builtlegally. The administration, he said, hadobtained a construction permit and alicencefor theuseof thebuilding.

Lack of public scrutiny is anotherproblem. According to Turkish media

reports, the Ak Saray project wasexempted from standard tender proce-dure on grounds of national security. Inmid-November, Turkey’s Chamber ofArchitects announced a separate 250-roomresidencewouldbebuiltalongsidetheexistingcomplex.

Mr Erdogan’s critics recall allegationsof rigged tenders, kickbacks andcrooked deals between developers andsenior government figures, which werethe subject of an investigation launchedin December 2013 and aborted thisOctober. This has increased concernsabout the climate of impunity in whichpoliticians and their preferred contrac-torsoperate.

Mr Erdogan does not appear con-strained by the criticism. As he put it inMarch: “No one can stop the construc-tion of this building and no one candemolish it.”

Signs of troublein developers’paradise as capitalstarts to dry upConstruction

A building boom alonecannot make the economycompetitive on the globalstage, writes Piotr Zalewski

Towering ambition: high rises under construction this year in Istanbul — Bloomberg

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