Turkey’s headline macroeconomic indicators can be the envy of not only its eurozone neighbours, but also certain Middle East and North Africa (Mena) nations with which Turkish firms are forming closer trade links. With 9 per cent gross domestic product (GDP) growth in 2010 and 8.5 per cent in 2011, Turkey recorded by far the best economic performance of any country in the Organisation for Economic Co-operation and Development.

Compared with the contracting eurozone economies, Turkey has shown impressive growth more akin to Asia than Europe.

The origins of Turkey’s economic resilience go back to the country’s 2000-01 financial crisis, which precipitated the formulation of an economic framework marked by prudence, fiscal consolidation and inflation targeting under an independent central bank and the overhaul of the banking sector. Turkey is now the world’s 16th largest economy, a far cry from its sluggish, tariff-bound state a few decades ago.

Turkey is now the world’s 16th largest economy, a far cry from its sluggish state a few decades ago

But the roots of this economic renaissance go back further than the millennium. In the 1980s, a series of reforms tore up the country’s focus on import substitution and concentrated on ramping up exports. The liberalisation of capital flows, supported by reduced tariffs and export incentives, fuelled Turkey’s gradual transformation into a trading economy. Ankara signed a Customs Union deal with the EU in 1995.

Meanwhile, successive governments maintained a focus on reform, kick-starting a privatisation programme that resulted in the sale of a series of state assets.

Turkey’s healthy finances

The economic policy framework has yielded high growth in tandem with single-digit inflation, healthy public finances and a strong reserves position. This legacy paved the way for Turkey to emerge from the global crisis much stronger than its neighbours, quickly recovering from a 4.8 per cent contraction in 2009.

Unemployment fell below 10 per cent last year for the first time since the 2008 financial crisis. Lending to the private sector picked up strongly. Loans to the private sector grew by about 40 per cent year-on-year from the fourth quarter of 2010 to the second quarter of 2011, to reach 48 per cent of GDP. With interest rates at historic lows, Turkey’s banks have been forced to compete for market share.

Timothy Ash, head of emerging markets research at UK bank RBS, says Turkey has reaped the reward of clearing up its banks after the 2001 crisis. “They cleaned up the balance sheets and these banks are now willing to lend and consumers want to borrow,” he says.

Just as impressive as some of the macro fundamentals is the fact that Turkey’s economic growth has been enjoyed not only by a well-connected elite. The benefits have spread across all social strata. This offers clear lessons for Mena countries, say analysts.

“Turkey has been able to manage inclusive growth,” says Sinan Ulgen, a partner at Istanbul Economics, a Turkish consultancy. “Other countries in the region that registered decent rates of growth on paper didn’t see the trickle-down effect. Most of the benefits of growth went to the people who were essentially close to the government.”

According to Ulgen, the way Turkey established a working framework between the market and the state eventually led to the phenomenon of protracted growth, and provides a lesson that would benefit almost all countries in the region.

Housing success in Turkey

Alongside the private enterprise-driven economic model, the governing Justice and Development Party (AKP) under Prime Minister Recep Tayyip Erdogan has delivered on a socially conservative agenda that has focused on family values. It has provided housing and a million new jobs each year.

“The state housing consortium has done a fantastic job of renewing the country’s housing stock and this has created a vibrancy; Turks feel good about themselves,” says Ash. “Erdogan’s success on the domestic political front has also assured stability, which combined with the success of projects overseas, means that Turks feel good about their future.”

If Turkey has much to be proud of in terms of its economic inheritance, it has no room for complacency. This year, the momentum of growth is likely to slide as the impact of the eurozone’s weakness erodes the foundations of Turkey’s export-driven economy. The EU is the country’s main trade partner, buying nearly half of its exports. A new recession in Europe would prove difficult for the Turkish economy to avoid. 

The Washington-based IMF forecasts much lower real GDP growth this year, in the range of 2-3 per cent. Inflation remains high at about 8 per cent, according to the fund, well above the central bank’s forecast of 6.5 per cent for 2012 and its 5 per cent target.

Internal dynamics will also shape economic policymaking. Turkey’s 2010-11 economic boom exacerbated several imbalances, says the UK’s Standard Chartered in a report on Turkey’s economy issued in March. Higher consumption and rapid credit growth were directly related to strong (volatile and short-term) capital inflows and much higher imports, widening the current account deficit to a dangerous 10 per cent of GDP.

Another problem is that Turks are spending far more than their counterparts in other emerging markets, yielding one of the emerging markets’ lowest savings rate at 13 per cent of GDP. Ankara is having to borrow more abroad, depending heavily on overseas markets to finance its widening current account deficit, which in turn makes the country more sensitive to external changes.

Analysts identify the current account as the chief source of economic vulnerability, aggravated by a divergence between domestic and foreign demand. The trade balance has also deteriorated, with Turkey forced to import increasingly expensive fuel and food, exposing it to higher commodity prices.

According to Standard Chartered, the year-on-year pace of export growth in October 2011 was 8.9 per cent, whereas imports surged by 15.1 per cent, indicative of a coming correction of the imbalance.

The government is addressing the issue, introducing a tax incentive scheme that aims to plug the current account gap by encouraging local production of goods that were previously imported. For some Turks, this is a reminder of the bad old days when import substitution was the guiding principle of economic policy.

Credit risks

Ratings agencies are less enamoured of Turkey’s economic prospects. In early May, Standard & Poor’s (S&P) cut the outlook on Turkey’s ‘BB’ sovereign credit rating to stable from positive, saying risks to its creditworthiness had risen as a result of its high debt and worsening terms of trade as demand for exports weakened.

The ratings agency estimated external financing needs will reach 142 per cent of current account receipts in 2012, one of the highest levels for any rated sovereign. “This heavy reliance on external savings exposes Turkey to shocks, either domestic or external,” S&P said.

None of this implies that Turkey is on course for a eurozone-style recession. The impressive groundwork laid by policymakers since the early 2000s cannot be unwound that easily.

There are some more favourable indicators. “We have seen a marked slowing in exchange rate volatility and I’d agree with the government’s forecast of 4-5 per cent GDP growth this year,” says Ash. “In the environment we are in, that is not that bad a performance.”

There could even be a rebalancing of growth, making it more sustainable compared with the 9 per cent growth seen in 2010-11. “The risk is definitely there,” says Ash. “But we have seen some volatility tightening and evidence of readjustment.”