Turkey: Wake Up to Rising Economic Risks

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Moreover, the liquidity crisis could spread to the Turkish banking system through foreign ownership of local banks. The share of foreign capital in the banking sector is currently about 40%, including 26% direct participation in banks and a further 14% in shares purchased on the stock market. Major foreign players in Turkish retail banking include Dexia (DEXI.BR), National Bank of Greece (NBG.DE), ING (ING.AS), General Electric Consumer Finance (GE), Citibank (C), and Unicredito (CRDI.MI). BNP Paribas (BNPP.PA) took over the Turkish operations of Fortis Bank (FOR.BR) following its acquisition of the bank's Belgium and Luxembourg operations.

Corporate borrowing has reached record highs despite the global turmoil. Turkey's central bank says the open foreign exchange position of nonfinancial companies climbed from $61 billion last December to $73.75 billion in March 2008. That figure is especially worrisome because a large share is with smaller, nonlisted corporations, whose ability to manage foreign exchange risks is not well known. Turkish corporations will have to pay an estimated $21 billion to $22 billion to external creditors next year; banks must pay around $14 billion.

Deficit Woes

Equally worrisome is the status of the current account deficit, running close to 6.5% of the economy and expected to exceed $50 billion by the end of the year. While declining oil prices will help reduce Turkey's energy bill, funding the deficit is likely to be challenging as capital inflows have already lost momentum and the quality of financing has deteriorated. Turkey attracted only $7.6 billion worth of foreign investment in the first seven months of this year, down 39% from the same period in 2007.

The government says it is determined to go ahead with a privatization program, but the credit crunch is likely to undermine how much it can raise by selling state assets. The privatization of four regional electricity distribution companies was not particularly successful, failing to attract major foreign interest. The secondary offering of Halk Bank (HALKB.IS) has been postponed indefinitely.

Exports are losing momentum on the back of slowing global economic growth. The trade deficit has ballooned 37% since last year, to a record monthly high of $8.1 billion in August. Economic growth, a relatively healthy 4.5% last year, is expected to slow to between 3% and 3.5% this year.

Yet the government has failed to produce a detailed, well-explained plan to minimize the risks created by the global financial crisis. For fear of locking itself into unpopular reform measures, it has stalled on making a follow-up deal with the International Monetary Fund after a three-year, $10 billion loan standby program ended in May. Though it could still agree to a precautionary standby agreement with the IMF, such a deal would be less reassuring to investors than if it had been signed in May.

Certainly, the government has limited room to maneuver in tackling some of Turkey's pressing economic problems. It could, however, take steps to improve confidence—and its failure to do so is both puzzling and disappointing.

Wolfango Piccoli is a London-based analyst in the Europe and Eurasia practice of geopolitical risk research and analysis consultancy Eurasia Group, headquartered in New York.