Moody’s, Standard & Poor’s and Fitch — these rating giants, along with multinational financial institutions, downgraded Turkey’s economic outlook. So how did Turkey turn things around?
Turkey’s economy expanded 5.1 percent in April, May and June, on the heels of similar growth seen in the first three months of the year, surprising many international credit rating agencies and financial institutions.
Big names — IMF, Fitch, Moody's, and World Bank — previously sceptical about the government’s ability to avoid a downturn have now revised their outlook for Turkey. The rating agencies' new estimates are in line with the government-run Turkish Statistical Institute, which expects full-year growth at around 5 percent.
The expansion in gross domestic product (GDP), one of the highest in the region, comes at a difficult period for Ankara.
Turkey has been dealing with threats on multiple fronts from militant groups, including Daesh and PKK.
The country was rocked by an attempted coup in July 2016, which the government says was instigated by FETO, an elusive network led by Fetullah Gulen, a Turkish congregation leader who lives in the US.
The group is said to have penetrated various Turkish state organs. As the government tried to restore order, it sacked thousands of its employees suspected of being linked to FETO.
That crackdown on anti-state actors along with a referendum on shifting to a presidential system in April 2017 have been a subject of constant speculation in the international press.
Istanbul-based private equity Turkven’s Chief Executive Seymur Tari notes in an interview with the Financial Times that public relations play an important role in how Turkey is perceived abroad.
“From 2002 up to 2007 we had some good public relations. From 2008 to 2012, there was a big hype and everybody wanted to be here. From 2013 onwards, the PR turned negative.
"In reality, we were never as good or as bad as our PR.”
So what changed?
A timely government intervention backed by steps to boost consumer demand shored up confidence and investments, analysts say.
Government spending, for one, increased over the past year. Once such initiative was to subsidise the employment cost of newly-hired workers and young and female workers.
Consumer spending was also bolstered for a few months through various cuts in taxes on the purchase of real estate, appliances and furniture.
Banks were encouraged to lend to businesses through the creation of a credit guarantee fund of 285 billion lira ($70 billion). The scheme assured banks that if borrowers fell behind on repayments, the government would step in.
“In last two years, SMEs (small and medium-sized companies or KOBİs) have faced difficulty in borrowing from banks due to insufficient collateral,” an official of the BDDK, which oversees banks, tells TRT World.
The credit guarantee fund led to an increase in SME financing by 70 billion liras ($18 billion) in the first eight months of 2017, compared to 32 billion lira distributed in all of the previous year.
While the economy was getting negative reviews and credit downgrades, Turkish ministers insisted that economic indicators were not as bad as they appeared.
“We have made an extraordinary improvement if you compare the Turkish economy’s resilience against financial shocks in 1990s and the years after 2002,” Naci Agbal, the country’s finance minister, said at an economic summit last month.
He was referring to the economic reforms initiated by the governing AK Party after coming to power in 2002.
Turkey went through a severe economic crisis at turn of the century. Runaway inflation, bankruptcies in the financial system and growing foreign debt wreaked havoc for households and businesses.
Turkish President Recep Tayyip Erdogan's government, which was initially seen by critics as too religious in a secular country, initiated bold reforms.
Establishing a competitive exchange rate, strengthening banks and offering tax cuts to businesses in the Anatolian region with a newly-emerging conservative middle class helped slowly prop up the economy.
The country was spending 86 percent of tax revenue only on interest expense in 2001. In the words of Mehmet Simsek, the deputy prime minister, "So if this was a company, it was essentially bankrupt."
Today, interest expense makes up only around 11 percent of tax revenues.
Since 2001, exports more than tripled to over $140 billion. The economy expanded to over $800 billion.
In the 27 years between 1975 and 2002, Turkey saw foreign direct investments (FDI) of $15.1 billion. From 2003 till now, it received $183 billion.
The Turkish economy’s exposure to international financial markets in shape of FDI, portfolio investment and borrowing makes some analysts uneasy.
But Suleyman Ozdil, president of the board of the state-funded Halkbank, says foreign investments are here to stay. “These investments won’t be pulled out any time soon. They have a leverage effect that reverberates throughout the economy.”
The Turkish lira’s depreciation, which intensified late last year, also helped exports.
“Exports have fueled much of the growth and that’s because other currencies have strengthened against the lira,” Gokhan Ovenc, an assistant professor of economy at Istanbul University, tells TRT World.
As the US dollar fetches more liras, Turkey’s exporters earn more and are encouraged to export more.
A cheaper lira also attracts foreign tourists, giving a much needed boost to the industry.
Turkish officials say an important factor neglected by rating agencies is Ankara’s relationship with Gulf countries.
Even though Gulf Cooperation Council (GCC) investments in Turkey slumped to $446 million in 2016 from $940 million in 2012, it remains a key investor.
“Qatar, Kuwait, and other Gulf countries see Turkey as a stable destination for their capital,” Ahmet Albayrak, who oversees international operations at Kuwait-Turkish Cooperation Bank, tells TRT World.
“Gulf capital has made some big investments in Turkey in recent years. Qatari investors have bought Finansbank and Alternatifbank. In addition, Kuwaitis bought Turkish Bank and the Lebanese took over Odeabank.”
How did the credit rating agencies get it wrong?
Turkish economic growth seems to have caught the rating agencies off guard.
None estimated the Turkish economy would grow over five percent. Subsequently nearly all the biggest rating agencies revised their predictions.
Some Turkish officials liken this to the rating agencies failure in correctly assessing the health of the global financial system before the 2008 recession.
“All the major rating agencies keep a cautious stance when it comes to Turkey. But they misread social, political and economic fundamentals,” the BDDK official tells TRT World.
The assumption after the coup attempt was that confidence in the Turkish economy would weaken and growth would flatline, Timothy Ash of the Bluebay Asset management tells TRT World.
“It was a kind of a fair assumption at the time. Now what we are seeing is that the data is much stronger than what we thought.”
Maintaining the momentum, however, could be difficult, Ash says.
“Put it this way: 2016 was a weaker year because of the coup. So the base year used for calculating growth in 2017 was low. Achieving 5.5 percent growth next year from a higher base (of this year) would be difficult.”
Nevertheless, Turkish officials feel rating agencies should remain cautious when estimating the impact of political events.
“Sometimes forecasting errors and the [inability] to deal with regime change results in biased credit ratings,” the official in the banking monitoring authority says.
“The rating agencies seem to be a bit more off target when it comes to emerging countries.”