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Sunday, September 16, 2007

The Current Outlook

Historically Turkey’s large financing requirements have made it particularly vulnerable to any sudden change in sentiment via a grinding to a halt in capital inflows, and what were perceived as weaker fundamentals than those which pertained in other emerging market economies (a large and widening current account deficit; a still high gross public debt ratio tilted towards instruments with adjustable rates or short maturities; and an uncertain inflation outlook) have often exposed Turkey to a sudden reversal of capital inflows.

The core argument of my recent extensive review of Turkey's current situation is that this situation need not be like this in the future. History is not condemned simply to repeat and repeat itself. There is evolution, and there is development. Again, if we look at the most recent one month chart for the euro-lira cross, we will observe that this time round Turkey continues to resist the pressure tolerably well:

(Since this chart is a measure of the number of lira per euro, the downward movement indicates a rise in the value of the lira vis a vis the euro).

True, with bank base rates at 17.25%, there may be good reason to expect the lira to appear robust you may say. The point is that Turkey is experiencing extremely tight monetary conditions and managing to maintain a relatively healthy annual GDP growth rate (an annualised rate of 5.3% over the first six months of this year), while Hungary, for example, which has a central bank base rate of 8%, is plummeting rapidly downwards into recession. It is the reason why the Turkish economy is exhibiting this resilience at this point which is what should be interesting us.

One of the explanations for this positive upside surprise would undoubtedly be Turkey's strong underlying productivity position. The history of the tiger phenomenon has clearly shown us that that factor accumulation alone, without accompanying efficiency gains, does not bring sustainable economic growth and rapid increases in per capita living standards. In Turkey’s case, however, productivity improvements have been one of the most under-appreciated aspects of the post-2001-crisis performance, and have been one of the principal drivers of the longest stretch of uninterrupted output growth in Turkey's history. In the pre June 2006 crisis period productivity growth had been steadily accelerating - reaching an annual rate of 8.5% towards the end of 2005, for example.

Output per worker surged at a year-on-year rate of 8.5% in the fourth quarter of 2005, up from 6.1% in the third quarter and 3.8% in the first half. Even in terms of output per-hour worked, the rate of productivity growth accelerated from an average of 4.7% in the first half of 2005 to 7.2% in the second half (and 8.4% in the last three months) of the year. This sustained productivity acceleration, as well as providing greater impetus to output growth, was also a big factor behind the massive disinflation which lead Turkey towards single-digit inflation territory. The rise in output per hour-worked in the manufacturing sector was somewhere in the region of 38% in the 2001-2006 period, easily outpacing the 32.5% rise in real GDP.

Also the 187.7% real increase in business investment spending on machinery and equipment over the same period - a reading which compares impressively with a "mere" 24.2% increase in construction expenditures — raised the capital/labour ratio and laid the basis for higher trend productivity growth in the longer run. The consequence of all this was that Turkey’s total factor productivity growth accelerated from an average of 0.5% a year in the 1990s to 4.8% in the post-crisis period, and this productivity boom will continue improving the quality and sustainability of non-inflationary output growth.

Fortunately, both the Turkish nation and the world at large have singularly and notably paid little heed to the strange warning which appeared on the Turkish military website to the effect that the nation was in peril. The nation is in fact in full health, and, guess what, a headscarf is simply that, something you wear on your head. As we have seen the only thing which may really be in peril is a privileged "insider" position in the old institutional structure, built up, strangely enough, via access to pension systems, their benefits, and the control which the consequent funds exercised over the old, tremendously inefficient, state sector.

Even so, some might have assumed given the past record, that a stand up fight between an elected Turkish government and the Turkish military might have negatively affected investor confidence, especially given the way in which the 2001 economic crisis was kicked-off by an apparently minor row between the then President - Ahmet Necdet Sezer - and the coalition government, all aided and abetted, of course, by a thoroughly rotten banking system. Yet in May of this year, when the AKP government undertook the initial public offering of 25% of the publicly owned Halkbank, it fetched $1.85bn, was seven times over-subscribed and finished trading the next day at an 11% premium. Something, it seems has changed. To plagiarize one former US president, it's the demography, silly!

Looked at another way, we could ask ourselves whether the reason why Citigroup paid a substantial sum of money (some would say an exceptionally generous sum) for a minority share in another Turkish bank (Citigroup paid $3.1 billion for a 20 percent stake in Akbank and indeed have only this month acquired the Turkish brokerage house Opus Menhul Degerler) earlier this year has anything to do with the fact that Turkey is actually the last pristine European market? At a time when investors across the globe are concerned about problems thought to be associated with the US subprime mortgage market, it should not escape our notice that house loans in Turkey are still a relatively new phenomenon - and constitute only 4% of GDP (compared to a European average of around 40%). Citicorp is not the only recent bank sector participant to enter the Turkish market, since the ING Groep, who are based in Amsterdam, agreed in June to pay $2.67 billion for Oyak Bank.

And there are more than banks to sell. Even while Prime Minister Recep Erdogan, who ironically chose a shining light bulb as a symbol for the AKP, struggles to keep electrical power generation on as the largely state-owned Turkish electricity industry continues to have trouble coping with high summer demand amid record heat it is worth reminding ourselves that Turkey needs all that extra power because its factories are humming, and because the ever wealthier Turks are demanding more and better services after 21 straight quarters of economic growth.

We should also remind ourselves that his recent electoral victory gives Erdogan the freedom to step up the sale of state companies and push for new foreign investment, so he can safely now proceed with plans to privatize the power companies. So the short term crisis has a solution, and in this case the reach of the new government may well not exceed its grasp. ie the problem, like so many others in the new Turkey, has a solution, and thus is likely to be solved.

Erdogan has made it very clear that one of the things he wants to do, in the light of the election results (nice pun that) is to put Turkey's power stations, regional electricity grids and the national lottery all up for auction. This follows decisions earlier this year, to sell the right to operate a group of airports in Istanbul and the resort city Antalya for $5.8 billion. Also in July, after years of delay, Petkim Petrokimya Holding, a state-owned chemicals maker, was sold for $2.05 billion to a group of Russian and Kazakh investors.

As a result, foreign direct investment rose to a record $19.8 billion in 2006 and has already totaled $11 billion for the first five months of 2007.

In the chronic inflation which characterized the domestic environment up until 2001, Turks simply did not borrow, or perhaps - better put - few would willingly lend to them. Consumer loans are currently 20 times higher then they were four years ago, although they still only constitute some 6-7% of GDP, while European averages are in the 35-40% region. As someone once said, there's gold in them there hills (the Anatolian ones, of course) and plenty of it, so let's go and dig. And as for me, ah, well now it really is time to go and smell the coffee.

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