Editor’s Note: Turkey’s Question

The challenge of country profiles is that they can take weeks to prepare and in the meantime, something big can happen. Such is the case in Turkey, an economic success story that has been overshadowed by the unrest in Istanbul and elsewhere in Turkey.

The protests are a reflection of many issues facing Turkish Prime Minister Recep Tayyip Erdoğan’s 10-year leadership run. On one hand, economic growth has not come without complaints that under Erdoğan, Turkey has sacrificed basic rights of Western democracies such as freedom of the press, unjust imprisonment and the lack of separation of governmental powers.

The explosive demonstrations in Taksim Square in Istanbul shed light on what many developing and established economies face – the sometimes tricky balance of economic growth and democratic rights.

Some argue such democratic policies are critical to a country’s long-term growth and attractiveness, but that’s not necessarily true. Non-democratic and some democratic countries with lousy human rights records attract investment and partners all the time and for long durations – think China, Russia, Saudi Arabia and to a lesser degree Singapore. What is generally required are free markets, stability and certainty. Those ingredients can be affected by other elements in an economy but usually take tremendous events to do so.

So the question for Turkey today is whether the opposition is reflective of a larger problem that could impede or harm its economic progress. This does not take away from the legitimacy of the demonstrators’ complaints, but it is worth watching to see if the certainty that brought so many investors in, will be undone by Erdoğan’s indifference to those who take issue with him.

— Jim Kharouf, JLN Editor-in-Chief

**Further Note: We reached out several times to Borsa Istanbul to speak with its chairman, Ibrahim Turhan. Unfortunately, an interview could not be arranged for this report.

It’s been quite a summer for Turkey – once a darling emerging economy for investors, the country has been turned on its ear over, of all things, a planned shopping mall on a park in Istanbul. That snowballed into massive demonstrations airing a litany of complaints against Turkish Prime Minister Recep Tayyip Erdoğan and sent investors to the exits.

The protests have subsided as the government backed away from building on Taksim Square but the damage has been done. As Erdoğan blasted critics and blamed outside investors for pushing its markets and economy down, there is no question Turkey has lost the sex appeal and momentum it had this spring. The protests told a different Turkey narrative – not the impressive growth story Erdoğan authored in recent years, but one that shows a soft economy and a country politically divided and, potentially, severely flawed.

Ultimately, investors fled its markets. The Borsa Istanbul Stock Exchange National 30 Index (BIST 30 Index) hit 98,243 on June 14 and then plunged to 86,060 during the crisis on June 24. The index recovered slightly since but stood at 89,793 on July 11. The MSCI Turkey ETF illustrates its slide from investor favor, as it topped $77.30 on May 7 before plunging June and tumbling to $55.11 on July 7. Investor outflows in that ETF alone totalled $38.6 million last week, largely on currency and central bank concerns mount as well as worrisome current account ratios.

Now, Turkey is a country that has outside investors asking: is this a country on the rise or decline because of its leadership? While growth stories like Turkey often persuade investors to forgive human rights problems, environmental concerns and even threats to democratic freedoms, they are usually spooked by an uncertain direction or economic worries. Turkey’s government suddenly appears off course and its economy is showing its warts.

Taking a Look Back

It’s quite a turn for Turkey, which has sold a good news story featuring rapid growth fueled by economic reforms following its own financial crash in 2001.

Those reforms paid dividends for Turkey, which got major credit rating upgrades, putting it in or very close to the “investment grade” category. Financial services reforms also paved the way this year for the merger of its cash equities and derivatives exchanges into the Borsa Istanbul, bringing the country a step forward toward its goal of becoming a regional financial hub. (See the video) And now Turkey is setting its sights higher, aiming to become the 10th largest economy in the world by 2023, up from today’s 17th rank.

The 2001 crisis was seen as a turning point for Turkey. It triggered a $10 billion International Monetary Fund (IMF) bailout package, but also fostered improvements to its public finance and banking infrastructure. Among them, the Central Bank of Turkey was given independence in implementing policy, allowing it to lower interest rates and move from a fixed to a floating exchange-rate. Such changes helped buoy the Turkish economy over the next several years, putting Turkey in a stronger economic position when the 2008 financial crisis slammed most of Europe and other major economies.

“Turkey managed to escape much of the recent [2008] financial crisis because of a strong risk management framework put in place in the wake of the 2001 crisis, in particular with an aversion to complex derivatives,” said Coşkun Küçüközmen, a lecturer at the Izmir University of Economics.

In addition, Turkish banks were put under further supervision following the massive failure of the Imar Bank in 2003, when Turkey’s Banking Regulation and Supervision Agency added more capital requirements and internal control systems, many of which were later implemented in the Basil II and MIFID rules. Turkey also improved its legal infrastructure. And it made the final payment on its IMF debt in May, a proud accomplishment for a country that spent 52 years in one IMF program or another.

In the past five years, the country’s GDP expanded an annual average of 3.3 percent, according to the World Bank. Turkey’s $800 billion economy is expected to grow 3.6 percent in 2013 and 4.5 percent next year, and 4.7 percent in 2015, the organization reported in June before the protests.

Real GDP Growth Forecast (2012-15)

Country 2012 2013 2014 2015
Vietnam 5.0% 5.5% 6.9% 7.1%
Indonesia 6.2% 6.1% 6.0% 5.6%
Turkey 2.2% 3.5% 5.4% 5.2%
Brazil 0.9% 3.1% 4.4% 4.6%
Russia 3.4% 3.5% 4.0% 4.1%

Source: Ernst & Young 2013 – Rapid Growth Markets Forecast

Fitch upgraded Turkey’s credit rating to investment grade BBB- in November of 2012, while Moody’s followed in May with an upgrade to Baa3, just below investment grade. And Standard & Poor’s upgraded its sovereign debt in March to BB+, from BB-, one grade under investment level. But those ratings are now under review. Fitch announced this week that it may lower its credit rating if the political problems persist in Turkey.

What’s Next – Challenges and Opportunities

To help Turkey reach its lofty goal of becoming the 10th largest economy, a public/private group has embarked on a $2.6 billion construction of a massive banking and financial district called the “Istanbul International Financial Center” which will span more than 170 acres and 45 million square feet of office, residential, hotel and retail space, including two office towers. It is scheduled for completion in 2016.

Like many emerging markets, Turkey’s central bank has fought to protect its currency, the lira. The central bank moved to stem the slide in the lira in recent days, selling a record amount of foreign-exchange reserves as it tries to adjust to the ripple effect of the US Federal Reserve Bank’s likely move toward ending its quantitative easing program. In short, the economy is facing some further headwinds.

Still, concerns linger about Turkey’s economy, including inflation, which averaged 8.9 percent in 2012, public debt which is 40.4 percent of GDP and the emerging market problem of “hot money.”

“Turkey’s biggest vulnerability is external financing,” said Vefa Tarhan, a professor of finance at Loyola University Chicago’s Quinlan School of Business, adding that it also has about $150 billion in debt that is coming to maturity. “Savings continue to be very low, and Turkey’s current account ratio is very high. The faster Turkey’s growth, the higher the current account deficit will be. For every dollar of exports in 2011, Turkey had to import $1.79.”

Turkey’s Foreign Direct Investment (FDI) Projects (2007-2012)

16.7%Business
Services
9.9%Financial
Services
9.9%Info., Comm.
& Tech

Source: Ernst & Young’s attractiveness survey — Turkey 2013

Despite Turkey’s efforts and growth, foreign investment declined from $15.9 billion in 2011 to $12.4 billion in 2012, according to the Organization for Economic Cooperation and Development. Turkey’s Central Bank reported this week that through the first five month of 2013, FDI inflows fell 35 percent from a year earlier to $4.22 billion, and that doesn’t include the period of political strife which began in June. Government officials still believe it is possible to match 2012 totals, but admit they would need major inflows in the second half of the year.

Tarhan said such numbers illustrate the dangers of so-called hot money – investment from foreign hedge funds and institutions attracted by the country’s comparatively high interest rates.

“Foreign hedge funds go to Turkey and buy Turkish stock, but mostly Turkish government bonds. That’s where the money comes from,” Tarhan said. “But that’s not long term money. If [the funds] get scared, if U.S. interest rates go up, the difference would narrow (between the U.S. and Turkey’s interest rates) so the funds would not be as attracted to Turkey.”

Turkey’s Financial Services Industry Distribution of Financial Sector Assets

77.8%Banks
9.6%Central Bank
of Turkey
2.6%Portfolio
Mgt.
2.1%Mutual
Funds
0.9%Pension
Funds
0.6%Brokerage
Houses

Source: Banking Regulation and Supervision Agency (BRSA)

The challenge for policy makers is to balance growth and inflation along with the current account deficit and the value of the lira, as well as Turkey’s relationship to the EU and potential membership there.

Going forward, given the country’s geographic position and plans for growth, it may revive opportunities for investors. Borsa Istanbul aims to be a major player in Turkey’s long-term ambitions and now has a major partner in Nasdaq OMX to get there.

Pulling off such deals and building its financial sector are two keys to keeping the foreign investment flows open and could make Turkey one of the most interesting stories in the emerging markets space. But how it deals with political opposition in the coming months will also go a long way toward reviving the feel good story that was Turkey.

Q&A: Valerie Bannert-Thurner on Nasdaq’s Partnership with Borsa Istanbul

Borsa Istanbul and Nasdaq inked a partnership deal early this month that includes a new trading and clearing platform for the consolidated exchange. JLN editor-in-chief Jim Kharouf, spoke with Valerie Bannert-Thurner, vice president of market technology at Nasdaq OMX, about what the deal means and how Borsa Istanbul is positioned going forward.

Q: Why did Nasdaq want to partner with Borsa Istanbul?

A: Overall, this is a big and strategic partnership for us. Turkey is one of the big and growing capital markets in Europe. It has huge potential and there have been big changes in the background with the new capital markets law and the formation of Borsa Istanbul, which folds its markets together.

Q: What will Nasdaq provide to the partnership?

A: We will provide them with technology to make sure they can be a regional hub, with state-of-the-art technology for everything – trading and clearing for all asset classes. That, in and of itself, is a good reason to work with them. But the other area we see an opportunity is to morph or form Istanbul into a regional financial hub.

If you look at that region overall, there is no central trading structure and I think Turkey is quite well positioned to become that regional hub for trading. So we will help them with our different businesses including with the listed companies side and how they interact with their brokers. And we will work with Turkey to develop capital markets in surrounding countries, with tools for exchanges, better technology and business development as well.

From our point of view, Nasdaq offers all these different businesses – technology, listed services, brokerage services and our own trading business to help Turkey grow.

Q: What will Nasdaq offer Borsa Istanbul in terms of technology?

A: They will merge all of their systems and markets onto the Nasdaq platform. So 80- to 90 percent of the market will be moving to Genium INET trading and clearing platforms and we’ll also provide the trading technology for energy, which is separate.

Regarding commodities, they have a lot of small commodities markets, along with gold. They are merging those together on a new, modern technology platform, thus making the post-trade cycle more electronic. So energies and commodities, not just in Turkey but across the region, are two growth areas.

Q: How long will the technology implementation take, especially since Borsa Istanbul is in the process of merging its cash and derivatives markets.

A: Borsa Istanbul is moving at an incredibly fast past pace if you look at just the past six months in terms of consolidating and creating a vertical silo. And one of the key drivers of that is also the planned IPO by 2016. So from our perspective, we want to make sure we launch at least one of the platforms during that time.

Q: Will using Nasdaq’s technology provide Borsa Istanbul better reach or distribution in some way?

A: Yes, that’s one of the aspects of our partnership. We want to increase the overall presence of the Turkish capital markets and products internationally. We’ll work with them and see how we can collaborate and attract additional flow as well as expand with some of our other big partners around the world. That’s something that will take shape and form over the next year.

Q: Ultimately, what is the potential for Turkey to become a regional financial hub?

A: In my region (Europe), I see a very clear trend toward regional hubs. And we’ve seen it before in other regions, such as in Nordic states, which has one market that encapsulates all of these smaller markets to make it successful. In Europe, I think that is very healthy.

I think this type of partnership is how you will see exchanges work together in the future – where you have strategic alignment that help grow different areas.

Q: Turkey has been in the news a lot lately, due to the protests against the government. Do you see that having any long-term impact on your partnership or the Turkey’s growth prospects?

A: From our perspective, we very much believe that capital markets help stabilize a region, help create a strong middle-class, and help create a stable economy. Hopefully, over time, it will help overcome the local challenges. We hope to make a social impact in the long run.

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