For the first time in history, the market views Greece's sovereign debt risk as higher than Turkey's. Turkish sovereign credit-default-swap (CDS) spreads—a proxy for risk expressed as an interest-rate premium over the London Interbank Offered Rate (Libor)—are 165 basis points (1.65%), while those for Greece are much higher, at 330 basis points (3.3%). That puts Turkey ahead of a handful of other European Union member states, as well: Sovereign CDS spreads for Romania are trading at 200 basis points (bps), Bulgaria at 190 bps, and Hungary at 185 bps.
That markets view Turkish debt as a better bet underscores the country's current economic strength. Even as international rating agencies were lowering Greece's credit rating two notches from A to BBB+ and Portugal's one notch to AA-, Turkey's was upgraded to BB+. The country's current account deficit as a percentage of gross domestic product (GDP) measures just 2%, compared with 5% for the U.S. and an eye-popping 15% for Greece. Much of the credit goes to Turkey's booming exports, which soared from $36 billion at the end of 2002 to $135 billion at the end of 2008. (The figure dropped to $102 billion in 2009, still a remarkable feat considering the global economic slowdown.)
Welcome to the new Turkey, where a sustained effort to establish civilian supremacy over bureaucratic institutions is under way. Dramatic reforms have been enacted aimed at strengthening the rule of law and increasing economic competition and transparency. Despite near-term challenges, the enforcement of private property rights and a dynamic competitive economy are in the process of being realized.
Driving much of Turkey's rise has been a concerted effort to soothe relations and boost trade with its neighbors, near and far. Turkey has seen significant increases in trading volumes with Asian, African, and Middle Eastern countries, as well as with Russia, helping to offset a steep decline with a recessionary Europe. The Turkish economy grew from being the 26th largest in the world in 2002 to the 17th largest last year, according to the World Bank.
Turkey also escaped the worst of the credit crunch, thanks to rigorous financial regulations. Enacted and supervised by Turkish state agencies, the rules ensured that the Turkish banking sector was one of the best capitalized in the world. During the global financial crisis, when banks from Wall Street to Continental Europe required massive injections of liquidity from their respective host states, Turkish banks didn't require a cent from the government. Moreover, the regulatory agencies have real teeth, with the ability to hold bank management personally liable for bank failures and to seize their personal assets and other business interests to repay the state.
Contrast this situation with the crisis facing Greece. Despite the government's stated determination to tackle Greece's massive budget deficit by cutting civil service salaries and raising taxes, the market still lacks confidence in an EU bailout. The Greek government will be in the market soon trying to raise money to roll over large quantities of debt coming due—some $14 billion by this summer. The EU is in a quandary given the potential for further writedowns at European banks with massive bad debt exposure to Eastern Europe. The manner in which the EU handles Greece's upcoming debt refinancing challenge will set the tone for the long-term viability of the union.
The finance ministers of 16 EU countries have made a generic statement that should push come to shove, they will pony up the necessary cash to shore up confidence in Greece's financial situation. This is consistent with the Franco-German policy of offering soothing words of support for Greece to work its way out of its deficit problem, while resorting to a hard cash bailout only as a last resort. The Franco-German duo even agreed to an IMF role in a Greek bailout. While highlighting the inherent flaws of the new Lisbon Treaty, an IMF-rescue scenario is not as absurd as one might initially think considering that the U.K. was bailed out by the IMF as recently as the 1970s.
The EU's Challenges
The game of brinkmanship between the EU and Greece will continue even with IMF involvement; the EU has given the Greeks until 2012 to bring their deficit below the bloc's limit of 3%. The implicit guarantee from the EU forestalls a near-term downward spiral in the Greek tragedy.
Of course, this crisis of confidence isn't just about Greece. Spain, Italy, and Portugal all face budget and deficit problems; new additions to the EU such as Romania and Bulgaria have even larger structural issues. And with all the focus on Greece, attention has been diverted from China, which has arguably the biggest economic bubble on the planet (albeit an indirect worry for the EU). As long as uncertainty hangs over so many euro zone countries, their common currency will likely continue to sell off against the U.S. dollar, although this devaluation will help European exports.
Claims that the Greece story marks the death knell of the European project, however, lack basic geopolitical grounding. Were it not for the protective umbrella offered by the EU, the Greek economy likely would have collapsed by now. Thanks to the EU, democracy and the rule of law remain unchallenged. But workers in Greece, Spain, Portugal, and Italy all will have to agree to sharp cuts in their pension plans and other benefits. Given the strongly statist nature of these countries, the necessary medicine will be slow to flow. Here, the EU can learn a lot from Turkey's experiences reforming its economy from a lethargic state-driven economy into a dynamic, globally competitive one.
Ultimately, this stress test can pave the way for a deeper union between member countries. By more seriously considering Turkey's EU application, an opportunity is presented for the union to deepen ties between member countries and become a more significant player on the global economic stage. We are entering an age where "emerging market" economies are transforming into far more compelling investment opportunities than some established "developed economies." The old, neat delineations are giving way to a more complicated, multi-polar global economic order driven by the economic and demographic realities of countries such as Turkey, India, and Brazil.
Union with Turkey
With Turkey in the EU, countries all over the Balkans would be able to ease their deficit woes by cutting back on defense spending. Greece spent roughly $9.7 billion on defense in 2008, compared to $8.8 billion each year in 2006 and 2007. Turkey spent roughly $11.7 billion on defense in 2008, down from $13 billion in 2006. By focusing resources and capital more toward education and investments in technology and infrastructure, the entire region can make itself more competitive on the global economic landscape.
Turkey's relatively young, educated, and dynamic population will provide an engine of growth for the European economy at a time of unease and uncertainty in global financial markets. With financial leverage much less relevant today than it was a decade ago, demographics will play an increasingly important role in determining a geographic bloc's relative position. If the EU is to remain globally competitive vs. the Chinese or the Indian blocs—not to mention holding its own against American economic competition—then Turkey's EU accession is an integral part of that strategy.
Turkey has made strides in bringing its laws and functions in line with European norms. Laws governing society have been liberalized to unleash the creative forces of the country's citizens and steps have been taken to strengthen the institution of the rule of law. The work of reform is not complete yet and challenges remain; let us hope that European leaders have the vision and the foresight to match and support these historic efforts.