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Chain reactions? | 31st March 2014

Why Turkey cannot escape geo-politics | When Turkey’s citizens went to the polls in local elections on Sunday 30th March, it is probable that President Erdogan’s Twitter ban featured more strongly in their minds than t-shirt exports to Europe, but maybe it shouldn’t have done. The economic growth and stability that was a key feature of the first few years of his Presidency have been dwarfed recently by substantially slower GDP growth, just 2% in 2013, a rising budget deficit, accusations of corruption and cronyism and rumbling under-currents of protests. An influx of 700,000 refugees from Syria is further putting strains on Turkey’s economic resources and the recent shooting-down of a Syrian jet on the Turkish border points to the vulnerability of Turkey to the spill-over from instability in the Middle East.

What a difference a couple of years make. Delta Economics is forecasting that Turkey’s export growth in 2014 will be 4.6% but this is under half the rate of growth of nearly 10% seen in 2012 and with imports growing 4.5% compared to just under 4% in 2012, there is no likelihood of the trade deficit closing any time soon either. The challenge for Erdogan, quite apart from restoring his reputation with his voters on the political front, is that he must also restore the reputation of Turkey amongst the investment community.

The first challenge will be to address the value of the Turkish Lira which has been falling against the US Dollar since the beginning of 2011, with a brief respite between the end of 2011 and the end of 2012.  However, this has had little effect on exports, which grew by 5.3% in 2013 (Figure 1).

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Figure 1 | Turkey’s Imports, Exports and Total Trade (USDm) vs Turkish Lira per USD, Last Price Monthly June 2006-Feb 2014

Figure 1 Source | DeltaMetrics 2014, Bloomberg

The recent intervention by the Turkish Central Bank to rescue the Turkish Lira by raising interest rates to 12% shored up the value of the currency in February but Foreign Direct Investment (FDI) is a more effective route for stabilising the real economy. FDI in 2014 is expected to reach its 2013 levels, but the more expensive currency will also exacerbate the trend of rising imports.  And at a sectoral level, only clothing has reached its pre-crisis export level (as shown in Figure 2). What the link between sectors and trade routes suggests is that the appreciation of the Turkish Lira up to the financial crisis was negatively related to trade and was fuelled to a large extent by hot money. Since then, it is the depreciation of the currency that has propped up trade; any attempt to shore up the currency could have a detrimental impact long-term on trade without sustained real investment. This is because short-term capital flows are not contributing to the value of the currency as much as they did pre-crisis; instead, Turkish trade relies on exports and inward investment.

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Figure 2 | Turkey’s key sector export trade growth, USDm, vs Turkish Lira per USD, Last Price Monthly, June 2001-Feb 2014

Figure 2 Source | DeltaMetrics 2014, Bloomberg

The second challenge will be to re-invigorate the move into higher-end manufacturing that was initiated through closer trade and supply chain ties with Europe. Delta Economics estimates that automotives generally will contribute the equivalent of USD 17.6bn to Turkish exports in 2014. While we are expecting exports of cars and goods vehicles to fall back slightly in 2014, exports of components are forecast to grow by some 4.9% reflecting the role that Turkey has forged for itself over the past decade in global supply chains.

However, as Figure 3a shows, Turkey’s trade in higher end manufacturing (proxied through clothing and automotives and even to some extent through iron and steel) is vulnerable to regional risk. Nine of Turkey’s top ten export partners are either in Europe where demand is flat and deflationary pressures increasingly evident, or the Middle East, where geo-political pressures are placing downward pressure on trade in the smaller nations by trade value.

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Figure 3a | Regional risk to Turkey’s trade

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Figure 3b | Regional risk to Turkey’s trade

Figure 3b highlights the third challenge: the higher-end manufacturing which grew so rapidly up to the end of 2012 is highly dependent on Europe while commodity and infrastructure trade relies more on the some of the least stable countries within the Middle East region. Delta Economics is forecasting that automotive trade with its five main export partners, including Russia, will decline during the course of the next year.

Figure 4 shows automotive exports to Germany and Russia. There does not appear to be any effect of currency depreciation on trade; the correlation is just 0.26 for Germany and 0.21 for Russia. More than this, we are expecting a significant slow-down in export growth of cars to both countries during 2014 suggesting that previous growth has been on the back of inward investment which has now stabilised.

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Figure 4 | Turkish exports of automotives to Germany and Russia (USDm) vs Turkish Lira per USD, Last Price Monthly, June 2001-Feb 2014

Figure 4 Source | DeltaMetrics 2014, Bloomberg

Decelerating export growth to Europe could be compensated by diverting attention to Turkey’s largest export partners in the Middle East, but this highlights the fourth challenge faced by Turkey’s leaders: that its exports to MENA are in iron and steel which themselves are a function of infrastructure development in that region. In the wake of the downturn and the Arab Spring, infrastructure spending has suffered and Figure 5 shows how regional volatility affects the growth path of exports for Turkey.

The substantial drop in exports between 2009 and 2010 reflects the collapse of the infrastructure boom in the MENA region at that time, particularly in the UAE. The sustained uncertainty in Egypt and Libya has meant that exports have not recovered to their pre-crisis levels and we are forecasting a net decline in trade to these countries during 2014.  And although trade has recovered to pre-crisis levels with Iran the growth is fragile and arguably will be highly dependent on the outcome of the on-going talks with the US and Europe to remove economic sanctions. We are forecasting growth in iron and steel exports to Libya, Iran and Egypt after Q3 2014, but the geo-politics of the region present a substantial downside risk to the forecast.

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Figure 5 | Turkey’s exports of iron and steel to selected MENA countries (USDm) vs Turkish Lira per USD Last Price Monthly, June 2001-Feb 2014

Figure 5 Source | DeltaMetrics 2014, Bloomberg

The final challenge is particularly prescient given the current situation in Russia. Turkey’s growth has to a large extent been fuelled by its role as an energy transit hub and, in turn, this has meant that it has become highly reliant on imports from Russia, for its own increasing demand and to supply its own export growth, particularly to the Middle East. We estimate it will import nearly US$ 7bn of refined oil in 2014 from Russia, which is roughly three times higher than its second largest importer, India. Nearly half of its top 30 export partners are in the Middle East with ten of its top 30 export destinations facing major geopolitical or economic challenges over the next year. These countries account for nearly 30% of Turkey’s oil exports and while we are forecasting substantial growth for nearly all these destinations, the potential for downside risk to this forecast is equally substantial.

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Figure 6 | Geo-politics and Turkey’s oil trade

Turkey cannot separate its politics, global geo-politics and its economic performance. It must attract real investment into its economy to reduce its dependency on hot-money flows. But to do this, it must convince investors that it is both politically stable itself and that it can over-come its reliance on Russian oil and trade with highly volatile countries while re-invigorating its innovation and manufacturing base in textiles, automotives and iron and steel. Geographically located as it is on a geo-political and sectarian fault line between Europe, central Asia and the Middle East, it is a microcosm of the challenges that the world faces during 2014 all of which are linked together through trade. Turkey’s voters in the future should think beyond their politics to realise that their economics may well be determined by a chain of geo-political events over which they have very little control.