Resurgent Turkey broadens horizons

As the eurozone continue to struggle out of recession, burdened by high debt levels and low economic growth, one country on its fringes has enjoyed a speedy return to growth. Turkey was not immune from the global slowdown, suffering significant shrinkage in its GDP during the first half of 2009, but the country has recovered well, and its growth looks to be sustainable.

“What we have seen so far this year are really very strong leading indicators in terms of what kind of growth we can expect,” says Eli Koen, co-head of emerging European equities at Union Bancaire Privée, and manager of the Ubam Turkish Equity fund. “The consensus at the start of the year was for about 4 per cent GDP growth, but we are seeing more and more people upgrading their forecasts and starting to look at 5 or even 6 per cent.”

It is primarily domestic demand that is leading this recovery, he explains, with the banking sector at the forefront, as improved levels of lending fuel consumer demand.

However the economic situation in Europe is of concern to Turkey, although these worries are related more to flows of capital and trade, rather than concerns that the crisis, especially severe in its neighbour Greece, could spread eastwards.

“I don’t think that what is going on in Europe at the moment, in terms of direct economic consequences, has much effect on Turkey, mainly because the root of the problem in Europe is related to debt, and Turkey is one of the least indebted countries in the world,” explains Mr Koen. “The main reason for that is the private sector in Turkey holds very little debt as a percentage of the country’s GDP. This is because of Turkey’s history of very high levels of inflation and very high interest rates.”

Until 2004-2005, Turkish banks were not lending to anyone other than the government or very large corporations, he explains. Small or medium sized companies, and consumers, simply did not have access to credit, and as a result the private sector is not indebted.

“The only sector that could and did borrow was the public sector,” says Mr Koen. “But as a result of the IMF agreement in 2001 the public sector has also been bringing down its debt levels, and its debt to GDP ratio has also been coming down, and is now at a reasonable level. From that perspective, when compared to Europe, Turkey looks very good.”

Turkey has long tried to gain access to the EU, but given the economic problems in Europe, membership may now hold less allure. The issue of whether Turkey should join strongly divides European governments, while US Secretary of Defence Robert Gates has claimed EU rejection is pushing the country towards the Muslim world. Nevertheless, Prime Minister Recep Tayyip Erdogan has said Turkey is still committed to EU entry, and has denied that it is shifting allegiances towards the Middle East.

Changing times

However the government’s foreign policy does seem to be changing. Turkey’s once close relationship with Israel has worsened of late. The relationship was already deteriorating before Israeli troops stormed an aid ship en route to Gaza in May, killing nine Turks. Meanwhile Turkey’s relations with Iran appear to be strengthening, having voted against new UN sanctions on the country.

Trade between Turkey and the 22 members of the Arab league has more than doubled over the past five years to just under $30bn (€23bn), although this remains a far smaller figure than trade with Europe, while Turkey has recently agreed to set up a free trade zone with Syria, Lebanon and Jordan.

Turkish companies may be broadening their horizons, but this is not borne out of any ideological reason. “Yes there has been diversification, but it is not a political thing, it is economic common sense,” says Jerome Booth, head of research at Ashmore Investment Management. “It is healthy for Turkish companies to diversify away from Europe, given the economic problems there, so they are now more insulated from further potential problems.”

One benefit for foreign investors looking to access Turkey is that the country has a well developed and liquid equity market, says UBP’s Mr Koen, with $1.8bn in daily trading volumes. As well as a number of mutual funds specialising in Turkish equities, ETFs are also coming increasingly to the fore.

“It is easy to get exposure to Turkish equities. There are a lot of companies in various sectors that are available for direct exposure,” he says. “There are a number of large Turkish companies that are not listed, but there are plenty available, and there are no limitations for foreign investors. It also has a very liquid futures market.”

The banking sector enjoyed exceptional growth in 2009, and the question for investors now is whether this growth is sustainable or was a one-off. Jacob Grapengiesser, partner and senior portfolio adviser at East Capital, an independent asset manager specialising in Eastern Europe, is confident that the banking sector still presents opportunities.

“The largest sector in our fund, and on the Turkish index, is the banking sector,” he explains. “Turkish banks were the ones in Eastern Europe that were least hurt by the crisis. They were properly capitalised, they knew how to deal with an economic downturn because of the 2001 crisis, and, in 2009, grew their earnings by close to 50 per cent. They had a fantastic year.

“They made money in technical ways: one, they had large bond portfolios and interest rates came down so they made money on those bonds, and secondly they had a so called maturity mismatch, meaning that the maturity of the loans were longer than the maturity of deposits and as a result they made money as interest rates came down.”

Although Mr Grapengiesser does not expect banks to grow by anything like 2009 levels, he does predict they will have another good year, with growth of between 10 and 15 per cent, impressive when compared to the rest of the region. “I think Turkey is the only country in Eastern Europe where we have seen this kind of performance,” he says.

“In Russia banks are also doing OK, but the government helped out the banks with equity injections, which did not happen in Turkey.”

Namik Aksel, chief investment officer for HSBC Global Asset Management in Turkey, agrees banking will remain profitable and a key holding in fund portfolios. “The banks that are more focused on credit growth and household loans will be our focus,” he explains, adding that another area worth looking at is energy.

“This is a growing economy, and that brings increased energy demands, while Turkey is becoming a centre for industrial production in the region, and so we foresee a shortage in electricity production.”

He also highlights the real estate sector, believing low interest rates and long-term growth are likely to stay, which, when added to the country’s demographic make-up, with a particularly young population, should keep the demand for housing high.

Resilient economy able to survive political hurdles

With a general election scheduled for July 2011 in which victory for the ruling Islamist-rooted AKP is far from certain, and an upcoming referendum in September on constitutional amendments, investors are monitoring the possible effects on Turkey’s economy.

“Six or seven years ago I would have given you a very different answer,” says Namik Aksel, chief investment officer for HSBC Global Asset Management in Turkey. “In past decades Turkey was deeply affected by politics, but now the economic situation is much stronger and resilient, and we have more room to afford political incapabilities going forward.”

He warns there is a risk of a possible coalition in 2011, with the government set to lose at least some of its support while the opposition is gaining in popularity. “But even if this happens I believe Turkey should keep its growth on track and its economy in a strong position, given its current dynamics, such as a strong currency. There is a shift in mindset amongst both foreigners and locals. I believe that foreign investors are looking at the country with more confidence, while locals, having long memories, are more wary, though I do believe they are slowly becoming more hopeful about Turkey’s future,” says Mr Aksel.

Jacob Grapengiesser, partner and senior portfolio adviser at asset management firm East Capital, says that from an investor’s point of view, the political situation, overall, is good because it is stable, and does not believe September’s referendum on the constitution will change that.

“The referendum will be seen as a vote of confidence for the government, but I think they have proved they are relatively smart in terms of how they manoeuvre in the political landscape, so I wouldn’t expect any dramatic outcome. Three months ago a lot of us were nervous about this referendum, and the market did suffer a bit as a result, but we have actually increased our allocations since.”