| Bulent Ecevit | ||||||
Turkey’s political and economic environment has been calm since February 2001 when a massive, unexpected devaluation caused the Turkish lira to lose 69% of its value over the rest of the year. But the lull results from incidental rather than fundamental changes.
The IMF, for which Turkey is now the biggest loan customer, has signed a new $16 billion cheque for 2002-04. This has averted an almost certain debt default. But what happens next year and the year after that?
Turkey seems to be stuck in a Japan-style no-growth recession. But Japan is swimming in wealth and its recession is a result of its political establishment’s inability to make reforms. Turkey is swimming in poverty but has been on an unprecedented reform binge since 1999.
Bulent Ecevit, the 77-year-old prime minister, who has been a prominent figure since the late 1950s, is no reformer. Nor are his two coalition allies, Mesut Yilmaz (right of centre) and Devlet Bahceli (extreme right). Nonetheless, they will be remembered as having authored the biggest economic reforms in Turkish history, although most of them were written and legislated under pressure from the IMF and Wold Bank. These two institutions have had unprecedented success in using the carrot-and-stick method to complete a reform package that had been under discussion since the late 1980s.
However, the reforms have had no visible effect on the Turkish economy. This is partly because the government is reluctant to implement them and partly because it will be years before their positive effects are felt. The new contracting and procurement law, for instance, will go into effect in 2004. Meanwhile, as the Turks are fond of saying, “not a leaf sways” in the economy, which is far from entering a path of self-sustained growth.
The bubble burst in 1999, leaving Turkish businessmen exposed and stunned. The economy was largely driven by political contracts and subsidized government handouts, tax holidays, investment rebates and export bonuses. Generations of governments borrowed abroad and used up deposits in private and public banks to finance businesses that had reached the end of the road.
There was something for virtually everyone. The state-owned Agriculture Bank gave loans to low-income farmers, which they knew they would not have to repay. Politicians and their cronies got millions of subsidized dollars to build hotels and factories or to buy banks. Many such companies are now found to be uncompetitive or even superfluous. Nineteen banks had to be taken into government custody after their shareholders and political allies allegedly stripped them off assets.
Rarely did businessmen need to dip their hands into their own pockets. “It was always someone else’s money,” as a Turkish banker puts it. Shareholders had little incentive to keep their money in the company. “Capital accumulation was also stunted because of endemic inflation and the fact that inflation accounting was not permitted,” says Mehmet Erten, general manager of Tekfenbank. “The accounts of the company and the accounts of the shareholder got mixed up.” Capital accumulated not in companies but in private hands and the bulk of it was deposited in overseas banks.
“Only 5% of Turkish industry is internationally competitive,” says Elif Bilgi, general manager of Istanbul-based HC Securities.
Although it became clear from the early 1990s onwards that the economy was destined for the rocks, politicians chose to do nothing until the end of the decade, when, as Turks say, the sea finished. At the end of 1999 the money ran out. The country faced bankruptcy. Ecevit had to place an urgent call to the IMF. A large loan package was prepared but the decline continued because the coalition took the money but dallied about in making reforms. The market noted this and in February 2001 the lira collapsed.
Had it not been for the September terrorist attack in New York and the subsequent invasion of Afghanistan, the US, which has been the behind-the-scenes architect of the IMF Turkish salvage programmes, might well have let Turkey go the way that Argentina went. “The only difference between Argentina and us is that they haven’t got Usama bin Laden,” says a Turkish banker who did not want to be named.
Saved for strategic reasons
Turkey’s strategic position saved it. When international investor George Soros visited Turkey in March to give a series of lectures he asked Turks not to criticize the army too much for its involvement in politics “because it may become one of your biggest export items”.
| Mehmet Erten | ||||||
The bulk of the new IMF funding will go towards repaying Turkey’s overseas creditors.
What makes the problem of recession look insoluble is that there is no substitute for state largesse, which had kept the economy afloat for nearly two decades. Laws have been passed to prevent state banks from acting as the politicians’ privy purse. The central bank has become independent and will not print money at political behest. And the state treasury can no longer borrow at will.
Private banks are also unwilling to lend as carelessly as they did in the past when their main function was to fund the treasury at huge profit. “If growth is to be achieved during 2002-03, it must be investment-led because it cannot be consumption-led,” says JPMorgan bank analyst Yarkin Cebeci. He argues that consumption will be constrained by the downsizing of the government and the banking sector and because net external demand will be a drag on growth given last year’s export growth and collapse of imports.
A combination of these factors has starved the private sector of capital and the prospects of this improving in the short term are slim.
Turkish companies need capital to grow but because capital markets are stunted, bank deposits are the sole source of loans. State banks, which used to be big players, have more or less withdrawn from the lending market. Private banks are reluctant to lend because last year’s devaluation has eroded their capital base and non-performing loans are at an all-time high. Credit risk is rising.
Non-performing loans rose to about 18% in November from 11% a year ago. “The problem is worse than what official figures suggest,” says Morgan Stanley analyst Serhan Cevik.
“First, the ongoing transfer of bad assets to the collection department of the Savings Deposit Insurance Fund (SDIF) lowers the aggregate NPL ratio. Second, private banks tend to under-report NPLs in order to lessen provisioning charges.”
Cevik says the number of failed corporations, firms and cooperatives rose by 16% to over 16,000 last year. The picture is worse among small firms where the failure rate increased by 31%.
“With rising unemployment and declining disposable income levels, credit card delinquencies also increased sharply in 2001,” he says. The list of non-payers rose by 90% to over 792,000 last year.
No-one to lend to
Tekfenbank’s Erten says the problem is not that bank loans are unavailable. “Banks have funds available for loans,” he says. “The problem is that companies that want new credits are companies that have lost their credibility. What they are really looking for is releveraging. Companies that we want to loan money to don’t want to borrow because they don’t see a future. Companies that are eligible for loans have diminished in numbers. So banks have either come to a halt or are withdrawing.”
Lending rates have come down. The all-in cost of a one-month dollar loan has fallen to 3.5% to 4% from a peak of 30% in 1999, when the cost of dollar deposits to banks was 11% to 14%. There was a corresponding drop in the cost of Turkish lira lending, says Erten.
Erten says that the real sector has to go through a restructuring and consolidation before the economy picks up again. There are signs that this is beginning to happen. Foreign companies have started buying family-owned firms that have run out of capital.
The IMF and World Bank have been very successful in getting Turkey to make the fundamental reforms necessary for the economy to make a leap forward. However, the programme is not yet complete and Turkey continues to suffer from an attitude problem. Much more needs to be done before it creates an environment to attract foreign investment. If the government does not falter, as it did two years ago, the economy might achieve self-sustained growth, but probably not before 2005.
An unfinished bridge across troubled waters
A growing number of economists argue that Turkey is stuck in recession because it has not developed diverse sources of financing for its companies. Capital markets, as a bridge between money and business, are an unfinished project.
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“When you talk about growing an economy you are talking about capital,” says David Edgerly, an executive of Garanti Securities. “Where is it going to come from? There is nothing except bank loans and shareholders’ funds. The capital markets have failed to mobilize capital. This forces Turkey to be stuck with the choice: do I grow or shrink inflation. If multiple sources of funding had existed for the companies they would not be asking themselves this question.”
Neither the government nor the SPK, Turkey’s capital markets board, has spent much time on this problem.
In Turkey, assets in mutual funds total $3.5 billion, compared with $17.3 billion in Portugal, $22 billion in Greece and $55 billion in Mexico. Mutual funds and pension funds as a proportion of GDP also throws up a pitifully small figure: 1.9% in Turkey compared with 14.7% in Greece and 28% in Portugal.
The law governing funds puts many obstacles in the way of their development. Only specified entities such as banks (by far the major players), insurance companies, pension funds and brokerage firms are allowed to found an investment fund. The sting in the tail is the rule that the founder must first advance 20% of the stated value of the fund.
“This is crazy on several counts,” says an expert who does not want to identified. “First, you should never have to state the size of the fund in advance of raising the money. You simply say you are trying to raise money for a particular fund and you get as much or as little as you can. The key is flexibility. Secondly, what Turkish bank in today’s world has the capital to even think about starting an investment fund of any size? Also, Turkish banks are justifiably afraid that the cash for an investment fund will simply come from their already small deposit base. Thirdly, if you are lucky enough to sell up to the stated amount of the fund you have no more product to sell. Just as the market gets hot you have to close your shop door while you apply for a capital increase. By the time the capital increase permission comes through in several months’ time the market may well have cooled off.”
Another bizarre reality is that the management fees allowed by the capital markets regulator are astronomically high. In the west, asset management companies are lucky to get away with charging fees of 0.75% of the amount of assets under management. Customers demand that fees vary according to the type of investment.
If, for example, the investment is in an index-tracking fund, fees are very low.
“In Turkey the customers pay an unbelievable 5.4% annual fee for the pleasure of having someone stick their funds in repos,” says the expert. “This is absolutely nuts and provokes gales of laughter and envy when I mention it in London or New York.”
Corrective steps would include the adaptation of European Commission directives on mutual funds. The personal pension law has to be rethought making pension contributions mandatory (they are now voluntary) and to shift from an absolute maximum contribution to a proportion of salary, as in Chile and Mexico.
Steps also need to be taken to increase sharply the amount of stock available on the equity market by requiring companies to free float a higher proportion of their stock. Currently less than 20% of the market capitalization of the Istanbul Stock Exchange (ISE) is available for purchase – ” a ludicrously low figure”, as one foreign fund manager puts it.
Of the 290 companies listed on the ISE, 190 have a free float of less than $10 million – a speculator’s dream. This low free float is one reason why Turkey constitutes such a small proportion of all available international indices, which by providing benchmarks determine to a large degree the amount of equity portfolio flows to a country.
“In the real world the big get bigger and the small get even more irrelevant,” says Edgerly. “Sooner or later Europe will be reduced to a handful of large exchanges. Any decent Turkish company will rush to get listed on those exchanges and leave the ISE rapidly.”
Experts say that the government has also got to get serious about new products introducing realistic convertible bond regulations, rules allowing short selling and permission for companies to buy their own stock. Regulations are also needed for corporate debt, derivatives, and similar instruments.
“If all of these happen 10 Turkish companies may have access to sources of capital other than the owners’ pockets (empty) or long-term bank loans (non-existent),” says Edgerly.
Kurtsan: healthy growth that needs a tonic
When Niyazi Kurtsan, Turkey’s leading manufacturer of herbal products, started his career in a pharmacy in Istanbul in the 1940s a chemist was a maker of medicines, not just a seller. There were herb gatherers who collected herbs and roots from mountain slopes and sold them to chemists and labs. Imported medicines were in short supply because of the war. “Doctors would write prescriptions of plant extracts, which we would convert into medicines by boiling or kneading, making pills or balms,” says Kurtsan. “It was fun to do and people got cured.”
| Meltem Kurstan | ||||||
By the 1950s chemist’s shops started filling with imported, factory-made medicines that had a longer shelf life than herbal-based cures, which had to be consumed within three to five days. Medicine, like everything else, was becoming mass-produced.
“The job of the chemist became easy,” says Kurtsan. “You pick up a box from the self, tell the patient how to use it, and hand it over. But what was I to do? I had two choices – become an importer of medicines and an agent of large pharmaceutical companies or continue with traditional healing and folk medicine.”
Kurtsan decided to stick with herbal products and he created Otaci – meaning doctor-chemist in ancient Turkish – Turkey’s best-known herbal brand. The group, which includes five companies including a joint venture in Uzbekistan, produces a wide range of herbal foods, cosmetics and healthcare products.
Turkey, which escaped the last ice age, is one of the world’s most plant-rich countries and has a wealth of knowledge in herbal cures. “Since we are so rich in plants, I thought I would continue with what I did in the back of my chemist shop on an industrial scale,” says Kurtsan. ” In rural Turkey people knew centuries before aspirin was invented that aspirin is good for you. How did they know? They love to sleep under the willow tree. They believe that sleeping under the willow is good for you. The bark of the willow contains acetylsalicylic acid. It is from this that aspirin is made. The people have inherited a lot of wisdom from the ancients and still use it.”
Otaci is most famous for its throat pastilles, in which it has about 15 per cent market share. Kurtsan uses not only local herbs but has also borrowed the method for making akide sekeri, a traditional Ottoman sweet obtained though boiling, to create unique pastilles.
At 77, Kurtsan is a picture of health, a living advertisement for his own products, of which he is the first and most loyal customer. He is still very much active and “thanks Allah,” he says, that “I am in perfect health and free of disease.” Can the same be said of the company?
Like most manufacturers in Turkey, Kurtsan is being hurt by a recession that has entered its third year. But because of its aversion to borrowing – a characteristic of the best family-owned enterprises in Turkey – it is not leveraged and has managed to escape the ravages of devaluation and high interest rates that have floored most private-sector companies.
It suffers, however, from a malady that is common to practically all Turkish companies: shortage of capital. From its inception Kurtsan has had to rely on the profits it generated and this, more than anything else, has determined its growth rate.
Kurtsan is confident that being a niche player will protect him from the recession. “We will have no trouble surviving,” he says. “We are not greatly ambitious. We make simple things. In general we don’t manufacture products that are of interest to big companies, big geniuses, big capital. Great inventions and pills are not our concern. We are only interested in people who are interested in keeping healthy. They are enough to keep us going.”
Family owned firms such as Kurtsan dominate the Turkish economy. They are now under threat from deregulation and the advent of multinationals that are spurring integration. To survive they will have to change their strategies and match the multinationals’ scale, focus, access to cheap loans and management techniques.
Kurtsan is in the process of turning over the business to his two daughters, Meltem and Deniz, both of whom are certified chemists. Deniz runs sales and marketing. Meltem, the elder daughter, looks after the production side and is already mulling over the choices awaiting them.
“Probably because we are a family company we have always shied away from borrowing from banks,” says Meltem. “‘Grow under your own steam,’ is our motto. We must be rare for not having loans. My sister and I think the company must find a way of growing faster. But my father has always got one foot on the brake. In view of what’s happening in the economy I am glad he has.”
She understands, however, that sooner or later something will have to be done. “The recession has forced us to shelve our expansion plans. We have stopped investing. There is a drop in our revenues.” Meltem thinks that a foreign strategic partner might be the best way to go forward. But the family is also considering going public or taking a private-equity partner.
