In Depth

Turkey's Moment


Turkish Premier Recep Tayyip Erdogan has had a busy two months. First he publicly defended a controversial investigation into a possible coup attempt by the army. Then the premier clashed with the hostile Turkish judiciary over the high court's right to ban political parties, including his own. On Apr. 9, the country's top prosecutor delivered a blistering speech against Erdogan, who many Turks fear is out to create an Islamist state.

This kind of political turmoil long made Turkey radioactive as far as the financial markets were concerned. So what are investors, including foreigners, doing now? They're buying Turkish stocks and bonds in record amounts. The Istanbul Stock Exchange index hit an all-time high on Apr. 9, capping a 52-week run that has seen stocks double in value.

Stoking investors' enthusiasm is the conviction that Turkey's economic fundamentals have improved so much in the past eight years that political strife won't stop the forward momentum. "This is an economy with a deep manufacturing base and a large middle class," says Murat Köprülü, the Turkish-born chairman of Multilateral Funding International in New York, which manages about $120 million of emerging-market assets. "[Turkey] is going to pick itself up again after a political crisis and show growth."

Erda Gerçek isn't fazed either. He left Turkey 20 years ago and has worked as a fund manager at Citigroup (C) and Legg Mason (LM). Recently he moved back to his homeland to teach fund management at Istanbul Bilgi University and Izmir University of Economics. "In the time I was away, Turkey went from a highly volatile, boom-and-bust economy to one that's relatively stable as inflation and interest rates came down," says Gerçek, 44.

Credit for this transformation goes to Erdogan and his deputy prime minister, Ali Babacan, who is a graduate of Northwestern's Kellogg School of Management. Erdogan's Justice & Development Party was elected with a strong majority in 2002. Speculative trading by Turkish banks in government bonds and the Turkish lira had triggered a financial crisis.

Erdogan and Babacan used their majority and capitalized on the sense of emergency to ram through numerous reforms. They reined in government spending, sold $30 billion worth of state-owned companies, strengthened financial regulatory agencies, and tightened capital reserve requirements for banks. They actively pressed for admission to the European Union, citing EU membership requirements as another reason for deep change. "It was bitter medicine," recalls Ziya Akkurt, chief executive of Akbank, one of Turkey's largest banks.

The medicine worked. Turkey had a prosperous decade as rates came down and banks started to lend after a period in which there was precious little lending. Foreign capital from Ford (F), Vodafone, General Electric (GE), and other multinationals poured in to build manufacturing in autos, appliances, and information technology. Trade with Europe and the Mideast boomed; exports have tripled since 2002, to $102 billion.

The real test of Turkey's financial strength came last year, as the global crisis tipped the world into recession. The country's gross domestic product contracted almost 5%, a painful adjustment. But the lira did not crash as it once did in dire circumstances. Instead the currency has held close to 1.50 per dollar since October 2008, even as the central bank has slashed interest rates by more than half, to a record low of 6.5%. The cost of insuring against a default on Turkish debt has plunged in the past 12 months, to 160 basis points from more than 340 a year ago. Six EU member countries, including Turkey's neighbors Greece and Bulgaria, are more likely to default.

Erdogan, 56, recently cast aside what he calls "walking stick" loans from the International Monetary Fund, which sustained Turkey through most of the past two decades. The premier announced on Mar. 10 that Turkey was breaking off almost two years of loan renewal talks with the IMF and turning its back on a credit line worth as much as $40 billion. Turkey survived the global economic crisis on its own without bailing out a single bank, Erdogan said, and it doesn't need the money.

Turkish businesses are now preparing for a strong year. GDP increased at an annualized rate of 6% in the fourth quarter of 2009, lagging behind only China among the Group of 20 nations. On Apr. 2, Deputy Prime Minister Babacan said the economy may have expanded by more than 10% in 2010's first quarter.

Affordable credit, says billionaire industrialist Ahmet Nazif Zorlu, is helping enterprises expand both at home and abroad. His Zorlu holding company, which already makes 15% of Europe's televisions under contracts, is now developing Turkey's biggest real estate project, a $2.5 billion hotel, shopping, and luxury apartment complex in Istanbul. Zorlu's company is also building what will be Israel's largest privately held power plant. Turkey's biggest bank, Is Bankasi, is on the acquisition trail, too, especially as beleaguered Greek financial firms prepare to shed assets, particularly in the Balkans. "We keep looking for opportunities, and I think the problems in Greece will trigger some interest by Turkish banks," Chief Executive Officer Ersin Ozince told reporters on Mar. 31.

A nascent high-tech sector is profiting from government attention. Bülent Çelebi returned to Turkey in 2004 after more than a decade working in Silicon Valley. His Istanbul-based company AirTies makes wireless routers and Internet TV technology, and he sees progress. "I used to come to all these conferences and think that nobody ever listens. But maybe they listened," Çelebi says of the Erdogan government. "They took tangible action. They said, 'OK, every school in Turkey is going to have [broadband].'" Türk Telekom in Ankara has extended broadband networks throughout the country, adds Çelebi, whose company had $36 million of sales last year. The more broadband there is, the more business there is for companies like AirTies.

Can Turkey keep up the pace? In 2005, Jim O'Neill, Goldman Sachs' (GS) chief global economist, listed Turkey among the "next 11" countries that could become world economic leaders (that's "next" as in "after Brazil, Russia, India, and China"). Sustaining a 6% average rate of growth could put Turkey's $620 billion economy ahead of Germany's by 2050, Goldman's Ahmet Akarli wrote in a follow-up report published in 2008.

Gerçek, the former fund manager, thinks that 6% average growth is "perfectly achievable." Turkey's demographics "can sustain very high levels of growth," and there's "ample potential" to put more young people to work in industries that are more productive, he says. More than a quarter of Turkey's 72.6 million people are under 15 years of age, while just 6% are over 65. Turkey is younger than China, where 19% are under 15. Young workers in an economy not only produce, they also start families and buy homes, a big boost to consumption.

Turkey's service economy is just starting to develop. "The Turkish market is still unsaturated in many banking products, such as insurance, mutual funds, pension funds," says Akbank's Akkurt. The bank earned $1.8 billion last year, while Citigroup (C), which owns 20% of the Turkish bank, lost $1.6 billion.

For all its advances under Erdogan, the Turkish economy still has soft spots. Prices increased 9.6% in March compared with a 5.1% rise last year, prompting some economists to question whether Turkey has solved its long-term tendency to inflation, which was 39% in 2002. "In the most disinflationary environment you can imagine, inflation bottomed. And in the blink of an eye, ping! It was back," says Akarli, the author of Goldman Sachs' 2008 report. This inflationary bent is all the more worrisome given that unemployment remains high at 14%. If the recovery really takes off and more workers are hired and wages rise, Turkey could find itself struggling with bad inflation again.

The other soft spot, despite the market's tendency to shrug it off, is politics. Erdogan's battles with his adversaries aren't over. Nor is the big question of Turkish politics settled: Whether Turkey should preserve its strictly secular traditions or follow the pious Erdogan and embrace Islam more closely. As part of that battle, Erdogan proposed constitutional changes last month that would make it harder to ban political parties. In 2008, the Constitutional Court rejected a lawsuit to close Erdogan's Justice & Development Party by a single vote. The premier also wants to increase parliament's role in judicial appointments, a move that indirectly would expand his influence greatly. Opposition leaders and top judges have lined up to denounce Erdogan for trying to politicize the courts.

Erdogan could become Turkey's longest-serving premier in more than 60 years if he wins reelection in 2011 as expected. Yet the attacks on him will likely continue until then, and at some point investors may grow alarmed. The next Germany? It's certainly possible. But even the skillful Erdogan could do with a stretch of political peace.

Holland is a reporter for Bloomberg News.
Bryant is a reporter for Bloomberg News.

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