Turkey has one of the world’s zippiest economies, but it is too reliant on hot money

Turkey’s economy

Istanbuls and bears

Turkey has one of the world’s zippiest economies, but it is too reliant on hot money

Apr 7th 2012 | ANKARA AND ISTANBUL | from the print edition

VISITORS to the top of the Galata Tower in Istanbul are treated to a panoramic view of the old town across the Bosphorus. Originally a wooden lighthouse dating from the sixth century, the tower was rebuilt from stone in 1348 by Genoese merchants. It is an enduring symbol of the benefits of foreign capital to Turkey.

Bustling below is a city of 15m that lies at the heart of one of the world’s fastest-growing economies. Figures released on April 2nd showed that Turkey’s GDP rose by 8.5% in 2011 after a 9% increase in 2010 (see chart 1). These are the sort of growth rates that mighty China would be pleased with. Jim O’Neill of Goldman Sachs, who coined the acronym BRIC to denote the big emerging economies of Brazil, Russia, India and China, has included Turkey in MIST, a second tier of biggish rising stars, alongside Mexico, Indonesia and South Korea.

But Turkey’s rapid recent growth comes with side-effects that have left its economy vulnerable. One concern is inflation, which was 10.4% in March—well above the central bank’s target and the inflation rates of most of Turkey’s emerging-market peers. A bigger concern is Turkey’s growing dependence on foreign capital to fuel its economy: its current-account deficit averaged 10% of GDP last year (see chart 2). Turkey’s deficit measured in dollars is second only to America’s.

More worrying still is that much of the foreign capital that finances Turkey’s current-account deficit is of the flighty sort (flows into banks or purchases of stocks or bonds), which can leave again quickly. Turkey wobbled at the end of last year as worries about the euro zone and its banks intensified. A chunk of Turkey’s banking system is part-owned by banks in the euro-zone periphery and half its exports go to Europe. Net foreign direct investment (FDI) typically accounts for only a small share of capital flows and precious little FDI is new factories or offices. “Before the financial crisis most of Turkey’s FDI was banking deals,” says Murat Ucer of GlobalSource Partners in Istanbul. “Greenfield investment has never been a big part of it.”

Enthusiasts brush all this off. Banks are well capitalised, even after a recent surge in credit growth. Public finances are enviable by rich-world standards. Public debt has fallen from 74% of GDP in 2002 to 40% last year. Inflation may be worryingly high but it is a big improvement on the near-70% rate in 2002.

Reforms to economic policymaking put in place after a financial crisis in 2001 have made the economy stronger. A recent research paper by Dani Rodrik of Harvard University showed that Turkey’s productivity record improved markedly in the decade after 2000, with average growth rates of 3-3.5% in GDP per person, GDP per worker and industrial output per worker. Income per head (in current dollar prices) has tripled in less than a decade to around $10,000 and there is still plenty of scope for Turkey to converge on the higher living standards of the rich world. Its big domestic market will become bigger: its 75m population is young and is forecast by the United Nations to reach 92m by 2050.

Turkey’s location is another selling-point. Its role as a trading post between east and west has been a lure for businessfolk since before the Genoese built the Galata Tower. Today Germany is Turkey’s main trading partner but Iraq, Iran, Egypt, Saudi Arabia and the United Arab Emirates are as important as a block. And these days the merchant class travels by air. Last year Turkish Airlines, a part-privatised carrier, flew 17m international passengers to more than 150 cities. There are plans for a new airport in Istanbul to secure its position as an international hub.

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