RECENT DATA INDICATE that Turkey has maintained a surprisingly good economic performance throughout the year. "It's the first time in my 18 years in banking that I have seen such figures," says Naci Sigin, general manager of Yapi Kredi Bank.
The 0.1% monthly rise in the September wholesale price index was the lowest in the past three decades, bringing the annual inflation rate down to 19%, compared with 92% in January 2002. The year-on-year increase in the consumer price index was brought down to 23% in September, compared with 73.2% at the beginning of 2002. Inflation may have fallen to a permanently lower level. Real GDP was up 5.8% in the first half of 2003, making Turkey one of the world's fastest-growing economies.
"The positive news flow that we had expected is coming through quicker than we had factored," says Lehman Brothers analyst Tolga Ediz.
The IMF's periodic review of the economy, usually a stormy affair, has gone well, with the Fund agreeing terms for the 2004 budget. The timetable for ending the review at the end of October was met, an unusual, not to say unique, occurrence for Turkey.
Responding to the good news, Turkey's central bank cut overnight interest rates to 26%. And given the positive outlook, it is likely to reduce overnight rates by another 300bp by the year-end, bringing 12-month yields down to around 27% by the year-end.
The national assembly has approved a government motion to send troops to neighbouring Iraq to help the Americans keep the peace. Although the Turkish prime minister has expressed reservations about this and the US is taking a cautious approach to calling in Turkish forces, the move will help to ease the tension in Turkish-US relations dating from March when the Turkish legislature prevented US troops from using Turkish territory to invade Iraq from the north. The US plans to give Turkey an $8.5 billion subsidized loan, which will reduce external debt financing next year.
The progress report on Turkey's proposed EU membership due out this month is expected to be positive and will be yet another boost to market confidence. In line with EU expectations, prime minister Tayyip Erdogan has passed legislation that reduces the army's influence in politics and increases freedoms for Turkey's Kurdish minority population.
"The EU is impressed with the steps taken by the Erdogan government," says Oktay Varlier, who was in a group of Turkish businessmen who visited Brussels in September to consult with EU officials. "For the first time the EU sees a government which is sincerely committed to membership," Varlier says.
Günter Verheugen, EU commissioner for enlargement, told German daily Frankfurter Allgemeine: "We have a government [in Turkey] that is grasping for reform as a goal in itself, independent of a rapprochement with Europe." Whether Turkey will be given a date for starting membership negotiations will depend on another EU report due out late next year. EU leaders meeting in December 2004 will formulate policy on Turkish membership on the basis of this.
The progress towards economic recovery was endorsed by Standard & Poor's and Fitch Ratings, which upgraded the sovereign's long-term foreign currency debt rating in October. Turkey has still to climb three to four notches before it becomes investment grade like Russia, which attained that status in October.
But Turkey is the epitome of boom-bust cycles and there is fear in the market that Erdogan's commitment to fiscal austerity is not wholehearted. Even as S&P nudged Turkey's rating upwards to B,
S&P analyst Ala'a Al-Yousuf pointed to such doubts. "Despite the government's repeated declarations of its commitment to the IMF-supported programme and its huge parliamentary majority, it has faced difficulties in adhering to its fiscal and structural reform pledges fully and in a timely manner," he says.
He adds that if the government continues to adhere to a tough fiscal adjustment strategy despite the local elections due in April 2004 and the expiry of the IMF programme at the end of that year, the potential for rating improvements would be increased. If it abandons the discipline of the programme, there would be pressure to downgrade.
Botan Berker, Turkey manager of Fitch Ratings, says that Turkey is a victim of political volatility and wavering, noting the way it has stagnated compared with other emerging European economies. "Turkey had liberalized its economy nearly 10 years before the Iron Curtain fell," she says. "But it requires five upward rating improvements before it can mount the lowest investment-grade rung. Why isn't it there already? Because it is unstable and inconsistent. The government's policies are vague. They say 'we are committed to the IMF programme', but you can see that they are thinking 'what can we do to get out of it?'"
Emerging Europe's laggard
The fall in inflation and interest rates will transform the banking sector, which continues to be dominated by a large number of small players. Since 1997, 21 banks have failed but there are still 37 in operation. The system is undercapitalized.
Total bank equity amounted to about $11 billion at the end of 2002, or 9% of total assets of $130 billion (compared with Deutsche Bank's assets of $900 billion). Among the four top-tier banks Akbank is the only one that has free capital.
Two factors hinder consolidation. Since 1994 all deposits in Turkish banks have been guaranteed by the state. This has eliminated the risk factor for depositors and emboldened them to entrust their money to dubious banks that offer relatively high interest or charge lower fees.
The government's huge borrowing requirement and the high rates of interest it pays on its bonds ensure that all banks, irrespective of size, are profitable. Indeed, small banks and small-scale foreign banks, which make up about 3% of the system by assets, were the most profitable because making money from government paper through speculation does not depend on economies of scale.
The blanket deposit insurance scheme is scheduled to be lifted next year. Assuming that the inflation rate continues to fall, the public debt burden will ease and high interest rates will be brought down to reasonable levels. This will force banks to shift their emphasis from public debt financing (40% of total banking assets are loans to the government) to such classic banking activities as extending credit to individuals and companies.